"A 60:40 allocation to passive long-only equities and bonds has been a great proposition for the last 35 years... We are profoundly worried that this could be a risky allocation over the next 10." - Sanford C. Bernstein & Company Analysts (January 2017)
"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria" - Sir John Templeton
"Life and investing are long ballgames." - Julian Robertson
It is no secret that I have been bearish on bonds for a relatively long time now, ever since I began writing about my short position via puts in the iShares 20+Year Treasury ETF (TLT) in 2016, and this view is being challenged, or I have been outright wrong, after a period of time where it looked like I nailed the top in bonds, depending on your perspective.
For a sampling of my past writing on the topic, you can read the following articles at your leisure for background if you wish, or you can cut straight to the chase below.
Ultimately, we have been in a bond panic, which is rapidly turning into a mania that has detached from almost all fundamentals, which is the characteristic of any bubble, which the bond market can be firmly classified as now being in a confirmed bubble, by the classical definition of a bubble.
Lost in the shuffle of this bond market euphoria, which has seen one amazing thing after another, is the fact that countries have been selling 100-year bonds (which is what we should be doing in the United States right now to fund infrastructure projects IMO), even fiscally challenged countries, like Argentina, which issued its own 100-year bond on June 19th, 2017.
A little over two years later, this sovereign bond is now selling for roughly 50 cents on the dollar, showing how fast a bubble can collapse, which could be the same future fate impacting other sovereign bond issues, which seem like they only go straight up right now, as investors chase sovereign bonds ever further into negative yield territory.
The lesson, do not get too comfortable, because much during like the housing bubble that preceded the unwind in 2008/2009, and the technology and telecom bubble that preceded the historic capital rotation in 2000-2002, sentiment, and prices can shift faster than investors imagine, changing the narrative in the blink of an eye.
Argentina Sells 100-Year Bonds
For a country that has defaulted eight times on its sovereign debt in the last 200 years, it was surprising that demand was so strong when Argentina issued 100-year bonds on June 19th, 2017.
(Source: Reuters, June 2017)
The bond issue, again for a country that had defaulted 8 times previously, and was just working through a recent default, the biggest sovereign default in history in 2001, was oversubscribed by nearly 4 times.
Global investors looking for yield, included sophisticated pension funds, were attracted to the 7.9% coupon yield.
Does that refrain sound familiar today, were many are touting 7%-10% "safe" dividend yields, and dividend constructed Portfolios.
What Happened Next Was Unexpected, Yet Predictable
Roughly two years later, after sovereign bond prices in Argentina were already under pressure, the unexpectedly wide victory margin, by a non-business friendly set of candidates, in a preliminary presidential election, sent Argentina bond prices further south, with the 100-year bond issue trading down from the 70% of par value to roughly 50% of par value.
This article explains the background, and what happened, with a few excerpts as follows. First an overview, then, the impact on financial markets (emphasis added is mine).
Argentinian assets plummeted in price today after Alberto Fernández, a left wing populist opposition politician, soundly defeated right wing incumbent president Mauricio Macri in a nationwide primary election over the weekend. The vote determines which candidates can run in the presidential election in October, and is seen as a key barometer of public opinion.
Another Fernandez victory over Macri in October may result in a bond default and reworking of the IMF’s support to Argentina. The possibility that a new administration would reverse Macri’s market-oriented policies appears to have spooked investors.
The Argentinian peso lost more than 30% of its value against the dollar at one point in trading today, and the country’s 10-year government bonds also sold off, trading near 60 cents on the dollar. Argentina’s MERVAL stock index quickly shed 35% of its value when markets opened.
Symbolically, the 100-year government bond that Argentina sold in 2017—heavily oversubscribed amid optimism about Macri’s administration—sank sharply. The dollar-denominated bonds’ price dropped from 74 cents on the dollar at the end of last week to just 54 cents today.
The severe drop in the Argentina stock market can be seen in the price action of the Global X MSCI Argentina ETF (ARGT), which is shown below.
Somewhat surprisingly, the ARGT ETF is still quite a bit above its 2016 lows, even with the recent sell-off.
Why is this the case?
Primarily because Argentina based e-commerce giant, MercadoLibre (MELI), which is listed on the Nasdaq market and has been one of the best stocks to own over the past decade (I wish I owned this one honestly), makes up roughly 27% of the ARGT ETF, and MELI's stock price has held up relatively well, which is shown below.
Value stocks, including agricultural and real-estate focused conglomerate, Cresud S.A. (CRESY), which was brought up in the Live Chat discussion in The Contrarian this past week, have taken the brunt of the decline, with CRESY on the verge of its lowest share prices since 2009.
In summary, in Argentina, the narrative shifted quickly, after investors oversubscribed, by roughly 4 times, to a 100-year bond issue just over two years ago, and this had a direct impact on the stock market, though that re-calibration is in its early stages.
Lessons To Be Learned For The United States
Investors, traders, and trend followers, have piled into bonds lately, spurred on by the price momentum, the price action of other sovereign bond markets, including Germany, and perhaps the fear of a forthcoming recession.
This has driven the iShares 20+Year Treasury ETF (TLT) to new highs, both on a price un-adjusted (for dividends), and a price adjusted basis.
The rush into bonds, which has been ongoing for roughly a decade now, with a recent push higher, feels very similar to the dynamic that occurred around the issuance of Argentina's 100-year bond.
Specifically, investors turned a blind eye to risk, in search of yield.
That narrative applies to the broader U.S. equity market today, where everyone is searching for yield, and has been searching for yield the past decade, pushed out the risk curve because of zero interest rate policy.
In this investment landscape, with bond prices dominating the narrative, and almost everyone searching for growth and yield, it is no surprise that the longest duration assets, which are the technology leading growth stocks like Microsoft (MSFT), Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Facebook (FB), Netflix (NFLX), and Salesforce.com (CRM), have become the largest stocks in the S&P 500 Index, as measured by the SPDR S&P 500 ETF (SPY).
Building on this narrative, the biggest stocks in the S&P 500 ETF, in order of current weighting, are MSFT, AAPL, AMZN, GOOGL, FB, Berkshire Hathaway (BRK.B), J.P. Morgan Chase (JPM), Johnson & Johnson (JNJ), and Exxon Mobil (XOM).
Is it any surprise that the top-ten weighted equities are dominated by growth stocks, and dividend growth stock favorites?
These equities have collectively kept the S&P 500 Index near its highs, even as there has been a rush to safety in the panic into bonds.
With the bond market surging (TLT is up 21.1% year-to-date), as the broader U.S. stock market, as measured by SPY, continues to be up strongly YTD, still higher by 13.5% as of this writing, led by the performance of interest rate-sensitive sectors like REITs, which are higher by 22.3% YTD, as measured by the Vanguard Real Estate ETF (VNQ), and utilities, which are higher by 16.0% YTD, as measured by the Utilities Select Sector SPDR Fund (XLU), what could go wrong?
Two years ago, everybody thought the same thing buying 100-year Argentina bonds, but look what happened.
Obviously, Argentina is not the United States, who boasts the broadest, deepest, financial markets in the world, but the rush for yield, and the disregard for valuations, and risks that may be closer to the surface, is the same, from my perspective.
Closing Thoughts - Where Are The Bubbles Today?
With the benefit of hindsight, clearly it was not a good idea to be buying 100-year Argentina bonds, as investors overlooked the risks, in a central bank infused rush for yields.
When history writes the epitaph on the end of the nearly 40-year bond bull market, Argentina's rise and collapse, might have a prominent spot as an event that kicked off a global rise in yields.
With the knowledge of a rush for yield that went wrong, where are the bubbles today?
Personally, these are a few bubbles from my perspective right now:
1. (A bubble) in the confidence in central banks to guide the markets with their all-knowing hands. 2. In bonds, with record bond ETF inflows near all-time price highs at the end of an almost 40-year bull market. 3. In yield-oriented investments as central banks have pushed investors out the risk curve for the past decade. 4. In growth stocks, which are the longest duration assets. 5. In passive investments, which are price insensitive, really price indiscriminate, buyers.
In closing, watch out for bubbles bursting, particularly in the bond market, as this can have a spill-over impact to the broader equity market, particularly in yield-oriented investments, and look for investment candidates, in the opposite of bubbles, which characterizes almost the entire energy sector right now, including this specific investment candidate, which I think might be the most loathed equity in the U.S. market today.
There is historic opportunity in the investment markets today. I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past. From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009. For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.
Disclosure: I am/we are short TLT VIA PUT OPTIONS AND SHORT AMZN VIA PUT OPTIONS AND SHORT SPY IN A LONG/SHORT PORTFOLIO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Every investor's situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.