Time to Look for Greener Pastures

22.06.2016 • Politics and War

From Capital and Conflict (GREAT BRITAIN)-

You’re in the homestretch now. And if this morning’s moves in the pound and equity indices are any indication, Remain is coming home like a freight train. There seems to be a default bias in human nature for risk aversion. But we’ll know for certain in a few days.

In the meantime, market moves (stocks, bonds, currency) could be quite explosive. You have lots of money that fled to the bond market for “safety” when the outcome of the vote looked uncertain. Now that money, assuming the outcome is Leave, will leave itself. But where will it go?

This is a question I plan to ask Tim Price during his quarterly conference call with readers of The Price Report tomorrow. Tim will be joined by a special guest, Charlie Morris, whom you know as the investment director of The Fleet Street Letter. The call will commence at 10.30am sharp if you’re already registered.

Tim and Charlie have both written about UK and EU stocks in recent months. If investors have avoided UK and EU stocks on Brexit fears up until now, that could change – and change quickly. But which stocks could benefit? And is it a trade? Or is there real value on offer?

Speaking of value that’s not on offer, have a look at the chart from Bloomberg below. Remember last week when I wrote to you about the 30-year Swiss government bond yield going negative, along with 10-year German bunds? Well rates have been headed lower for 10-year US Treasuries too.

cac-pic-20-06

The chart doesn’t show 10-year Treasury yields, though. It shows you the premium typically received by 10-year Treasury investors for choosing a longer-term security over a shorter-term one. Note that until recently there was a premium. The Federal Reserve calls it a “term premium” and you can read all about it here if you like.

Non-trick question: when is a premium not a premium?

How about when it’s negative? The term premium on the 10-year US Treasury was recently negative 0.5268. That’s why the line on the chart above goes below zero on the right hand side. You’re not getting any extra compensation for lending long-term to the government. You’re getting slightly less loss, which is compensation of a sort I suppose.

In a highly risk-averse market, no one wants any compensation for risk taking. They want safety and capital preservation. Any port in a storm. The negative yield on government bonds is, then, a kind of “capital preservation premium.” But what now?

Well, you could make the argument that bond yields are headed even lower (and thus bond prices higher). For one, lower is where governments (who borrow) want them. Further, both the Bank of Japan and the European Central Bank are big bond buyers. That pushes yields down and bond prices up. And of course, the Federal Reserve is now clearly reluctant to “normalise” interest rates (and push yields up) in a global economy with sluggish growth.

Can you see the tension? The risk-averse money in the bond market, post Brexit, is free to seek greener pastures. It’s starting to do so already, now that the Brexit result leans toward Remain. But is there anything decent to buy? Where is the green? And where are the landmines?

That’s the story investors need to think about now. And it goes well beyond this week’s events. As I’ve written in this week’s MoneyWeek cover story, central banks have created a bond market monster. The “endgame” for quantitative easing (QE) is going to be a mess. And it’s coming sooner than you think.

Of course we still have Brexit to get through, before we can go beyond Brexit. On that, I present the below from Paul Tustain, the founder of BullionVault. You can read the original essay here.

It’s worth reading because Paul knows a lot about money. But also because Paul reckons Brexit will probably be bad for his company, diverting many new European customers to other firms. But in a private capacity, as a Briton, he’s voting Leave anyway. I’ll let him show you why in his own words.

-If you want to read more, visit capitalandconflict.com (English)-

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