The CFA Society of Indianapolis held its annual investment symposium last month, with an outstanding line up of strategists, ranging from Jeff Rosenberg of Blackrock to Chen Zhao of Brandywine. As in any market, there are buyers and sellers, bear and bulls, and among a group of strategists the case is no different, as the Goldman Sachs strategist argued that a recession was not imminent while the First Eagle strategist felt that there was a strong possibility for a recession in the coming months. While there was uncertainty surrounding the direction of the economy, there was consensus that the ongoing experiment with negative interest rates was problematic. Significantly, Japan recently had a 10-year auction which settled at negative rates. There is no little irony here: investors unnerved by the increase in volatility and fearing losses in the equity markets, purchase securities that have a guaranteed, albeit defined, loss over a ten-year time horizon!
According to this group of strategists, no one really has a handle on the significance of what negative interest rates mean. Negative rates completely disrupt the business model of financial institutions, which is why you have seen such a strong sell off of financial institutions since the start of the year, especially in Europe. Further, negative interest could have the paradoxical effect of encouraging excess savings, as individuals are forced to save more to make up for the meager returns on fixed income instruments.
Negative rates, and the prolonged period of low interest rates in general, have contributed to over investment and excess supply in many areas of the economy. It has allowed many marginal companies to continue to limp along, disrupting the normal life cycle of the economy where weak companies are bought out or enter bankruptcy.
The collapse of oil prices is a case in point. The United States dramatically expanded its investment in shale gas and oil fields, owing to cheap debt. This in turn led to the world becoming awash in oil and then to a subsequent fall in oil prices. The many oil companies that used debt to fund their drilling have seen their bond prices collapse, as the market waits for a broad swath of bankruptcies. At the same time, the low oil prices have put tremendous pressure on the budgets of the oil producing countries such as Saudi Arabia, Russia, Venezuela, and Norway. This has led the sovereign wealth funds of these countries in turn to sell equities so that funds can be repatriated to meet the looming budget deficits.
One of the arguments coming out of the symposium is that as these junk bonds and loans connected to shale oil collapse, they will in turn effect the financial institutions that hold them and which must write them down. This will in turn feed into the larger economy, just as the subprime housing collapse fed into the larger economy.
In general, there is concern that the massive intervention of the various Central Banks has run its course, and that fiscal stimulus needs to be introduced, although the political will to do this seems to be absent. Economic growth is in short supply.
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