Vaseline Finance – 0% Corporate Borrowing Costs
By Julien B. Booth
April 28, 2016
Macroeconomic Outlook – Vaseline Finance – 0% Corp. Borrowing Costs
Unilever Corp. (100’s of top consumer brands, including Vaseline, Dove et al.) borrowed 5-year funds this week @ 0%. Let that sink in a moment: 0%. Financial gravity is officially suspended. Money no longer has any time value (until it does). See http://goo.gl/FpQJT3.
The past three months have seen a remarkable recovery in asset (read: stock) prices as bonds were already having a wonderful 2016. Earnings are declining (historically a BAD thing for stocks) – yet prices are firm. 0% discount rate = infinite P/E ratio I suppose. Personally, I have very serious concerns about the complacency in the asset markets (read: deep concern).
We continue to favor bond, and bond-like instruments (muni, preferreds, utilities, REITs) when it comes to return of capital (first and foremost) before return on capital. Ironically, risk-averse securities are trouncing risk(stock) based assets from a return perspective.
The two largest themes that concern us most regard macro trends that are hard to fully quantify, but represent MASSIVE pressures on the interest rate complex: Capital Recycling and Capital Flight.
Capital Recycling: As bonds mature the proceeds are usually reinvested in like bonds. With interest rates far below historical levels, reinvested capital must be paired with new capital to net the same net $cash flow = stronger demand for U.S. bonds.
Capital Flight: The chart below shows the degree of negative-yielding global bonds. Global asset managers (pensions, endowments, etc.) will be forced to allocate money to U.S. bonds vs. negative-yielding European/Japan bonds = stronger demand for U.S bonds.
These are macro trends that will play out over the coming months and years. The ten year U.S. Treasury yield has declined by 21% this year (current: 1.84%). The 10-2 spread has contracted by 16% YTD and 26% over the past year. These are telling moves. See Japan.
The victims of crashing yields are some of the least able to shoulder the burden: pensioners and retirees. They are being starved for yield. Attached is an article concerning a troubling trend that is just getting started: Pension Cuts: WashingtonPost. We are likely early on this warning – as the implications will not be realized for some time.
With low rates pensions cannot meet their return “expectations”. The stock market return assumptions may be even more flawed (starting valuations here: http://www.multpl.com/shiller-pe). Many a pension will become insolvent. Prepare accordingly.
The inherent asymmetry of fixed income (limited gain, complete loss) forces income/credit security managers to perform comprehensive due diligence and ensure investments remain MONEY GOOD. We created Sixty Guilders Research for this sole purpose.
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.