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Wednesday, 19 December 2018

Vanity fair

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It’s a simple market truism that the guru’s just the guru ‘til the guru gets it wrong. 

Markets, especially bond markets, seem obsessed with the forecasts of Bill Gross, now of Janus Capital but once the world’s second most powerful investor when he ran Pimco, and Jeff Gundlach of DoubleLine Capital. They are predicting the end of the world as we know it and I’m sure they’re not entirely wrong. We must inevitably, at some point, watch the longer dated trends in both bonds and equities draw to a close. The biggest game in town at the moment is pointing to the end of the 30-year bond bull market. We three have all been here for those 30 years and I can tell you that it might look like a slam-dunk bull market when looking back at the long-dated charts but living it day to day, month to month and year to year it didn’t look like that at all.

 

Marking time 

Anyhow, what’s attractive about having to invest one’s coupons and one’s redemptions, let alone one’s new inflows, at ever-lower returns? We might have been clocking mark-to-market capital gains as we went along but every bond, if we’re lucky, redeems at the same price at which it was issued and if the coupons don’t make at least the rate of inflation, and we’re realising nothing but negative real returns, where’s the bull market? Bonds aren’t equities. Stocks can and should rise and rise. But a bond redeems at par unless it has defaulted and in the greater scheme it’s of no consequence whether it has traded up to 150 or down to 25 during the course of its life. Strict mark-to-market of bond portfolios has probably brought more pain and misery than any other phenomenon and I’d happily suggest that without it we’d never have had the global financial crisis. The proof of the bond is in its regular payments of interest and in its timely and full redemption. All the rest is vanity, a game of comparing, contrasting and quantifying relative value. But bonuses, some very big bonuses in certain cases, have been paid on this vanity calculation. 

Equities are idiosyncratically priced and brokers spend their life trying to behave as though one could look for relative value while bonds are priced on relative value while brokers try to find stories that point to idiosyncrasy.

 

Bull run 

Bond markets, as they have behaved since they were hijacked by the monetary authorities post-2008, have not been in bull mode. They might have been on a mark-to-market basis but in reality they have done nothing but force investors who are tied down by strategic asset allocation models to lock in future losses. Let’s face it, anybody who locked in somebody else’s money for 30 years at 2.28%, the low yield of the US long bond, or at 0.34%, the low yield of the long German Bund, evidently hadn’t noticed that the bull market was long behind us. On a mark-to-market basis it might not have been for billionaire fund managers such as Gundlach or Gross, but for the pensioners whose money they were playing with it ended when long yields had dropped below 4% or maybe already at 6%. For the little guy at the end of the line the bear market has been in place for years and the bull market will return when the entire curve begins to show a positive real return. 

A sharp fall in bond prices might enable end-investors to acquire coupon streams that mean something to them, even if it does mean that the Bill Grosses of this world don’t make quite so much in performance fees as they have done in the past and that can only be good. Paying somebody fees and bonuses for booking mark-to-market gains when you can’t get it back from them for future mark-to-market losses is a mug’s game. If the authorities like the muppets behind MiFID II really wanted to make markets more honest, they’d move away from mark-to-market and revert to good old lower of cost or market accounting. The old boys were quite right when they insisted on the latter on the basis that it’s madness to tax somebody on a profit or a loss that has not been realised. In the same way that the financial crisis demonstrated what a fallacy it was to dump Glass Steagall, so it also proved that strict mark-to-market creates more problems than it resolves, unless of course you’re the asset manager or the front book trader and calculating your bonus prospects. 

Between hitting the low yields and reaching sociable returns again there will be a tricky interregnum. The central banks have gifted us some staggering returns over the past few years, higher than we could have ever earned by skill and knowledge alone, and having to hand back a bit this year and maybe next should not be treated as a hardship. Everything is up in the air and the reality check begins next week with the opening of the US earnings season where current equity levels will find themselves verified or rejected. The rest is, to come back to that phrase, sheer vanity.

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