For a while now, I have been warning about the bubble being blown by ZIRP in many of the “Hunt for Yield” securities.
I first wrote about this topic late last June in relation to Annaly Capital ($NLY) in Analyzing Annaly.
While $NLY has paid $1.40 in dividends since, the stock is down over two times that amount (from $16.64 to a current $13.50) for a total loss of 10% vs. the S&P’s total return of over 25% in the same time span.
A week later I wrote Treasuries are bubbling and opined that people buying 30 Year Treasuries at 2.70% were doing so to flip to others at lower yields / higher prices. I argued that no one in their right mind would buy a 30 year bond to hold until maturity.
Later that month, buyers could have flipped it at under 2.5% for a decent profit, but as I warned, at a current interest rate of 3.31% you would have a substantial unrealized loss.
Similar to the preceding two posts, I was early with my warning on high yielding defensives when I wrote Blue Chip Utilities = Red Portfolio?. In this case, even more so. As a matter of fact, less than a month later I wrote QE Failed, and concluded:
“PS. I do realize that this post seems to somewhat conflict a prior post of mine titled “Blue Chip Utilities = Red Portfolio?“”. “IE - Are high yielding blue chips at this stage a good or bad investment? (Short answer: They SHOULD be much lower, but are you willing to fight the Fed?)”
The key sentence ironically was in the parenthesis. They should have been much lower, but that didn’t mean you shouldn’t buy / sell them.
“The risks outlined in those posts have all become greater and extended, sort of like extending the dot-com crash from 1999 to 2000.”
“The “hunt for yield” caused by #ZIRPforever should bring continued demand to high yielding junk bonds, REITs, & high yielding blue chips (Staples & Utilities), while the sub-par growth in the economy should cause cyclical names to underperform.”
And that brings us to the post I wrote a month ago today – “It’s Time to Fight the Fed” - things were getting out of hand, the divergence became historic, and I opined that the market in general was ripe for a pullback, and more specifically the Hunt for Yield securities were way ahead of themselves. My conclusion:
“stay safe, raise some cash, buy protection, & don’t chase!
To the investors chasing these yields, it might not be as bad as picking up a nickel in front of a steamroller, but it’s pretty darn close. Think of the risk vs. reward here – long term.
And to those “smart” investors (who must have only skimmed through the first set of charts of this post…) “tiptoeing” into these names because you’re trying to be prudent and take less risk. You might only be tiptoeing, and doing so ever so carefully & quietly, but you might have just tiptoed yourself onto a train that is about to derail.”
In this case it looks like my timing was impeccable.
$XLU (the epitome of hunt for yield stocks) is down ~8% since (vs. +3.5% & +5.5% for $XLI & $XLF respectively.)
$REM (which follows the NAREIT All Mortgage Capped Index) is down over 10% with many levered Closed End REIT Funds doing much worse.
Even $TLT (20 year treasuries) is down over 6%. That’s almost 3 years worth of dividends wiped out in one month!
But if things are really as I expected why have cyclical / high beta stocks rising?
As my buddy @ElliotTurn so eloquently “ranted” about on May 29th (check his feed and #FF him!)… There is no single reason to why markets move. Markets are made by so many participants each using different processes to what, why, and when they invest. So while the following might very well be me “anchoring” and finding explanations to construe the data in a way it would fit my original thesis, it’s still accurate to some extent.
I think it has become quite obvious that while the markets have initially been led higher by the “hunt for yield” & “tip toe” investors (hence defensives outperformed), this last month has turned into a “hunt for beta” causing tremendous outperformance by high short interest / low quality names.
I do not believe there has been an economic improvement to justify the markets holding up this last month. It’s mostly from the initial underperformance and the current need to catch up. It’s as if many investors & money managers woke up on May 1st and said… “Damn, we’re up 7% YTD, but trailing market by 7-8%” etc. We need to catch up.
This to me explains the markets overall rise for the month – which clearly was very different than the first five months of the year. There was a major shift in leadership.
And what about the huge rise of the 10 year Treasury bond? A month ago the 10 year was at 1.63%, as I write this it’s >50 bps higher. (The 10 year chart was actually one of the charts that I pointed to as diverging in last post.) Why are rates rising? Doesn’t that normally indicate growth?
Of course bulls explain this rise as investors front running a supposed tapering, but if the economic data isn’t improving why would people be expecting a tapering?
My explanation: I really believe people – to a certain extent – have begun to fight the fed. With QE in full force and the economy still struggling, people aren’t talking about expanding QE, (although the Fed’s last statement did say “The Committee is prepared to increase or reduce the pace of its purchases”,) people are talking about tapering, and how QE should be wound down.
With people witnessing what’s going on in Japan and how quickly things can turn around with regards to inflation expectations, I think the worst case scenario outcome of the QE experiments are gaining some traction. I don’t think the hyperinflation hawks will swoop back in full force anytime soon, but slowly – as QE expands and economic data continues to struggle, the scare alone has pushed inflation expectations higher.
I didn’t think that so soon after the post last month we would see this 180 degree shift in these assets. I hardly ever focus nor care about such short term movements. Having said that, I think what I wrote last month is still true today.
Obviously, as some of these securities have pulled back, they have a better risk/reward proposition now than a month ago, so it’s not as across the board as before. I wouldn’t be surprised to see a rally in the long bond and some CEFs. (Some CEFs are now trading at 10+% discounts to NAV vs. premiums a month ago.) But over the long term, if you’re thinking about buying these assets for “safe” & modest returns because you think there’s only minimal risks, think again. On an absolute level, there’s still a lot of room to go.