We start this week with an editorial in the Financial Times penned by Blackrock’s CIO of Fixed Income entitled “ECB can boost growth across Europe by buying stocks.” In the piece, he argues that negative interest rates aren’t helping Europe’s economy because it is depressing financial institutions and their willingness to lend money.
Many European zombie companies, if their fates had been decided by markets, would have folded many years ago. Had that process started a decade ago, by now, rather than needing further life support, they would likely have been reorganized and born again. Instead, they were granted perpetual reprieves through negative interest rates and ECB asset purchases. Now serious people are floating the idea that the ECB should buy the stocks of European companies to stimulate growth. It seems like more of the same to us.
Imagine if the Federal Reserve announced tomorrow that they were restarting Quantitative Easing, but instead of buying Treasuries like previous rounds of QE, they were going to buy corporate bonds and U.S. stocks! While we agree that negative interest rates are indeed harming Europe’s economy, we don’t view extending central bank asset purchases to stocks as a path to right the ship.
Further down the European economic rabbit hole, we look to a recent Wall Street Journal article highlighting how some Euro-denominated high yield bonds now trade with negative yields. Yes, you read that right. Some European “high yield” bonds cost you money to own them! The ECB is seeking ways apart from negative interest rates to juice the economy and the idea of the central bank buying corporate bonds is now seen as likely. That has pushed yields down on all types of European fixed income and has now put a minus sign in front of a few high yield bonds.
You may be asking yourself, why should I care what the Europeans do?
Because our interest rates are largely tied to theirs. For example, over the last 30 years the 10 year U.S. Treasury has almost never traded more than 2.5% above a German 10 year bond. Today, the German 10 year yields -0.35% and the U.S. 10 year yields 2.09%, meaning we’re only a few basis points away from the traditional “cap” on yield differences. In other words, Europe isn’t Las Vegas; what happens there spreads to America in one way or another.
From there we move east to Indonesia with a recent WIRED article entitled “The Sea Is Consuming Jakarta, And Its People Aren’t Insured.”
Jakarta is the largest city in the fourth most populous country in the world. The article states that through a combination of aquifer pumping and rising sea levels, north Jakarta (the side closest to the Java Sea) could be completely submerged in the next thirty years. The poorer parts of the world, both because of geography and lack of financial resources, are likely to bear the brunt of climate forces in the near future.
Apart from the doom and gloom aspect of the piece, the under-insured nature of the developing world is worth focusing on. As much as everyone hates paying insurance premiums, it should be highlighted that the most insured places on the planet are also the most prosperous. Insurance frees up capital to be put to work in more productive places. One of my all-time favorite books, “Against the Gods: The Remarkable Story of Risk” by Peter Bernstein, takes the reader from the beginnings of understanding probability to the modern, hyper-insured world we live in today. It’s well worth your time.
We finish this week with an interesting profile of the private equity giant KKR.
Long known as “The Barbarians at the Gate,” private equity firms were perennial pariahs and outsiders on Wall Street. Now they run Wall Street and most of Main Street. Private equity continues to attract assets from pension funds who have long term investment needs.
The old model of buying a company, loading it with debt and flipping it five years later only works when you’re running small amounts of money. Now that firms like KKR are managing trillions of dollars, they’re becoming business builders rather than business busters. I was shocked by this quote from the article: “By far the biggest innovations at KKR have been structural. A few years ago, on a plane ride back to California, Roberts made a revealing calculation: Had KKR been able to hold on to its investments in perpetuity, it would have a bigger market capitalization than Berkshire Hathaway.”