In the most recent issue of The Economist, several articles were written about the rise of superstar corporations. These are companies such as GE, Amazon, Google, Apple, that dominate the sector they are in, generate large amounts of profits and defend their dominant position by buying out the promising new-comers. Such consolidation in the corporate world is being driven by globalization, regulation and the advancement of technology, as well as low interest rates.
Low interest rates, in theory, are supposed to help drive innovation, entrepreneurship and competition. It is supposed to lower the cost of starting new business and risk-taking. However, in reality, the large corporations benefited much more from the low interest rate environment, and in the last few years, they have taken advantage of low interest rates to consolidate and buy out their competitors. The playbook is simple: use debt and some equity to buy out the competition; gain synergy benefits through cost cutting; gain bargaining power with suppliers and customers by reducing the competition.
These transactions are great for corporate earnings, but bad for the economy because they reduce the job opportunities and competition in the marketplace. Paypal’s founder, Peter Thiel said it best: “Competition is for suckers.”
This is one example of the unintended consequences of the easy monetary policy. Last night, the Bank of Japan (BoJ) met, and they pledged to set the 10-year Japanese Government Bond (JGB) yield to 0%. In a normal environment, 0% would feel like a very low rate, but in Japan, 0% is actually a fairly high yield, as illustrated in the chart of the week. Japanese bank stocks rallied 5% on this news, which is a deviation from earlier central bank thinking. Previously, it is considered good to bring the yield lower across the curve. After a few years of this, central banks are slowly realizing that a flat yield curve is seriously damaging the earning power of financial institutions. Without a healthy financial sector, economic recovery will not be robust.
Another new talking point coming out of central bankers is the effectiveness of monetary policy. None of the major central bankers have said monetary policy is not effective any more (they can never say it because they need credibility to influence the market), but we are hearing more talk that monetary policy is very accommodative already, and it has helped the economy a lot. More central bankers are suggesting the need for more fiscal stimulus and structural reform to fully take advantage of the easy monetary policy. It is likely we will see more stimulus and reform after the election and into 2017.
Global bond yields reached record lows this summer. The buying felt like panic buying, especially after the Brexit. The European Central Bank (ECB), BoJ and Bank of England (BoE) are big non-economic buyers of duration, meaning they are buying bonds with little regard to what price they pay. For a few days, we even saw the BoE could not buy all of the bonds it intended to buy because there were no sellers. People are not selling their long bonds because they worry they cannot replace these long duration assets.
Key Takeaways: There are a lot of unintended consequences from a long period of easy monetary policy. In the last 35 years, being long duration has been great for a bond portfolio manager’s performance. In the coming years, it will become more and more dangerous. The reward is slim when yield is so low and curve is so flat. The risk is more elevated now because lower yield means higher duration risk for the bonds of the same maturity.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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