If he were writing about today’s fun and games, Twain might take that invocation, apply it to bonds and turn it on its head. “Don’t buy bonds,” he would say, “they’re making too many of them.”
Actually, the detail would be a bit more subtle as another famous, and far wealthier, resident of Connecticut is saying. Ray Dalio – billionaire and perhaps the world’s most successful hedge-fund manager – spelt it out for Bloomberg Markets and Finance. “You would be pretty crazy to own bonds,” he said of the post-Covid-19 world to come. “Effectively owning a bond is having a promise to receive currency, and they’re going to be making a lot of currency.”
‘They’ are the world’s central banks, who will be riding in tandem with the world’s treasury departments to fill holes in the income accounts and balance sheets of the private sector. In the process, they will be supplying an awful lot of liquidity and credit to companies and consumers. To put that into a loose context, if the UK government’s bailout spending sticks at around the £350bn first mooted, that would account for about 15 per cent of the UK’s annual output and would raise government spending by over 30 per cent.
Granted, at this stage of the game, governments are playing by the book – excess spending will be funded in the proper way, via the sale of government bonds to investing institutions, they say.
So far in the UK, that’s not in doubt. The Debt Management Office plans to raise £45bn in gilts sales in April alone, more than it has ever sold in a single month. The previous record was £28bn, raised in July 2009 as the effect of the US sub-prime crisis peaked. Even after inflating that £28bn for the size of the UK economy today, it still comes in slightly below April’s planned amount at £42bn, says the Institute of Fiscal Studies. Despite that, institutions are falling over themselves to buy the new stock. The most recent offering, £2bn of Treasury 1¾ per cent 2049, was oversubscribed 2.4 times and sold at slightly over £128 for an average redemption yield of 0.7 per cent.
Give it time, however. A return of 0.7 per cent is not going to satisfy too many long-term commitments for pension funds and insurance companies, not even with inflation at its current depressed 1.7 per cent. At some stage, these institutions will become both sated and wary. Whether that will be the point at which Treasury departments start selling their debt to central banks, or whether that process – just quantitative easing via a different channel, they will tell us – will have started earlier, who knows? But the effect will be the same. As Mr Dalio adds: “You just can’t produce money without having an effect on its value.”
Yet he also appreciates that governments and central banks are somewhere between a rock and a hard place. They have little choice but to do what they’re doing. “Central banks will do practically anything to save the system,” he says, which – if push comes to shove – would even mean buying equities.
According to another investment industry A-lister, Nassim Nicholas Taleb, that would be as bad as it gets. “Bailouts, by definition, have a problem,” the man who introduced the investing world to black swans told Bloomberg. “They are not bailing out you and me. They are bailing out investors and corporations. They are bailing out those who did not have a buffer. And not to have a buffer is irresponsible whether you are a corporation or an investor.”
Harsh perhaps, but probably true. And especially true if, as Mr Taleb maintains, the Covid-19 pandemic is not a black swan (ie, completely unpredictable) but is of a class (ie, pandemics) that has been widely predicted.
That aside, Mr Taleb’s underlying point is more important. We live in an investment world of ‘fragility’ (his word for investments that can’t stand much knocking around) and ‘fat tails’ (feedback loops that mean extreme events happen more often than theory says) where the law of large numbers does not apply. In that hostile landscape, ‘robustness’ (that would be, say, Unilever’s shares today) is useful but only goes so far. What’s really needed is stuff that’s ‘anti-fragile’ (assets – mostly options – that love it when the going gets rough).
This is another way of saying portfolios need insurance, most likely achieved by having deep out-of-the-money put options in the markets that best reflect their assets. For most IC readers, with the FTSE 100 index at about 5700, that would mean Footsie puts with the right to sell at around 4500 (20 per cent below current levels).
Most of the time such contracts would expire worthless. So the premium – much like the premium on household insurance – would be nothing more than a sunk cost. Very occasionally, however, a contract would pay out big time; big enough to offset both the cost of all the little premiums paid and, more important, to rescue your portfolio. It’s a must-have. As Mr Taleb said on an earlier occasion, “if you don’t have insurance, you don’t have a portfolio”.
