Money for Nothing

Many years ago, back when I was just a young pup in 1985, a British rock band named Dire Straights released a song called “Money for Nothing“.  It hit number 1 on the US charts for 3 weeks…and proved oddly prophetic.  Money for nothing?  Who knew?  (Great song by the way…check it out.)

Which, of course, leads us to our 2016 version of “Money for Nothing.”   Here are the two summaries…and the BLOG starts below:

Why you should care:

Global interest rates (of all durations) will remain at – or below – current levels.   Lower is possible; longer is likely.

In an April 21st statement, the ECB laid out details of their plan to purchase European corporate bonds.  The objective of the program, according to the ECB:  “…the programme will provide further monetary policy accommodation and help inflation rates return to levels below, but close to, 2% in the medium term.”

Whether or not the ECB is successful in lifting inflation, one clear direct result will be further reduction – across the board – in rates on European debt instruments.    Of all types.  Which, in turn, has the ‘contagion’ effect of putting downward pressure on the debt instruments of all developed nations – including, of course, the US.

Taking action:

‘Interest rate sensitive’ investments (those with values inversely correlated to rate movement, such as real estate, REITs, utilities, US bonds) remain a solid bet for the foreseeable future.  Stick with them.   

US ‘yield’ investors fear near-term rate increases.   Good news:  They won’t be rising soon…so you can relax.   They will fluctuate, but within a relatively constrained trading range.   For the foreseeable future.

If you’re invested in – or are considering – real estate (whether by yourself or in REITs), a near-term hike in rates can drive values down.  It’s worth worrying about.

But not right now.  Save that worry for another day.   (One REIT I particularly like is ‘O‘ [Realty Income Corp] – which I’ve owned for about 1.5 or 2 years.  Here’s a chart from earlier today.)

In 2016 YTD, it’s up about 20% against the DJIA.   But it’s an income generator.  At this price, about 4% per year.  And it pays a monthly dividend.

Why I like (and own) O: 

• It’s well diversified.  Its portfolio includes approximately 4,540 properties in 49 states, of which over 4,519 are single-tenant, net-leased properties. 
• It pays a monthly dividend.   As of February 2016, it has paid 537 dividends in the 47 years since its founding in 1969 (do the math:  that’s about 45 of the 47 years), and has increased the dividend 84 times since the company was listed on the NYSE in 1994.

THE BLOG:    MONEY FOR NOTHING

Will it work?   Can the ECB effectively ‘push up’ Eurozone inflation rates with this action (when combined with prior QE actions)?  Or are they pushing on a rope?

After a few other efforts to push up inflation, in March of 2015 following the FED lead, the ECB began buying government bonds.   The program target was about $1.2 trillion in size.

Nope, inflation didn’t budge – in fact, it declined further.  So they extended the program.  And on March 10th of this year, the program was expanded a third time.   Thus increasing the ECB ‘assets owned’ on their balance sheet from about 1.4 trillion Euro in 2008 to about 2.8 trillion Euro today:

While they peaked at 3.1 trillion Euro in June of 2012, today they hold about 1.4 trillion Euro more than in 2008.

Today’s ECB plan is to acquire corporate securities, too, thereby increasing total bonds owned.   Still with the intent of pushing up the European inflation rate.

Beginning in June of 2016, six national banks acting “on behalf of the Eurosystem” will start buying corporate bonds denominated in Euro.  They are able to buy up to 70% of any single corporate bond issue – which, according to analysts, is a MAXIMUM potential total pool of about 867 billion Euro.

How much – in total – do they plan to buy? Well, according to research by Deutsche Bank, it doesn’t matter.  Regardless of their plan, the maximum is further reduced by liquidity and risk issues.   Possibly as low as 552 billion Euro.

Which means the ECB balance sheet might grow by about another 800 billion Euro, but probably less.

So, will it work?

As you know, the same plan didn’t work in the US.  You may recall the FED began purchasing US Treasury securities and ‘mortgage backed securities’ (MBS) during their ‘quantitative easing’ phase.  Buying Ts and MBSs, growing the FED balance sheet, has NOT resulted in increased US inflation.  Or a pick up in GDP growth, as was also intended.

And the FED bought a LOT of assets:

As of April 20th, they now hold (own) almost $4.5 trillion of assets!  Up from less than $800 billion at the end of 2008.   (And while there are implications of this, too, we’ll discuss them in a later blog.)

Which means the FED bought about $3.7 trillion of Ts and MBSs between 2008 and today.

So … for the (same) plan to work in Europe … one would surmise the ECB would need to buy more credit securities than the FED, right?  After all, if the ECB hopes to be more effective than the FED, they have to go bigger than the FED.

But they will not.  Not even close.  All in, they’re probably a lot closer to a 2 trillion Euro increase – or about $2.3 trillion.   Far below the size of the FEDs ‘QE’ program.

I don’t think they can win here.   The deck is stacked against them.

But private corporations will win!   And win big!  The imbalance is already showing up in the bond markets.  There are simply too many buyers, not enough sellers.   And the excess demand is driving bond prices up and yields down.   How far down?

Earlier this week the global consumer-goods conglomerate Unilever took advantage of the imbalance and floated a new bond issue.  Of the total 1.5 billion Euro issue, 300 million were sold – get this – WITH AN INTEREST RATE OF ZERO!

Let me repeat this:  The company that makes Dove soap and Ben and Jerry’s ice cream just sold debt – to actual, in theory intelligent, investors – that pays the investor NOTHING!  Except, of course, the principal.   And when will they get that back?  Their principal?   Oh…really soon…in 2020.

WHAT?   In 4 years?

What insanity would cause an investor to buy a bond with a -0- interest rate, tying up their money for 4 years, and think this is a GOOD idea?

Sir Arthur Conan Doyle, in the voice of his brilliant Sherlock Holmes character opined, “Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth.”

The truth must be these investors aren’t morons.  At least they all can’t be.  They must be anticipating even further rate reductions in future corporate debt issues.   They must expect the coupon yields to go below zero – negative – and, when this happens, the principal value of their investment will increase.

Thus, like ALL investors, they DO expect a return – but one from capital appreciation, not interest income.  A risky plan, for sure, but this is the only logical reason for this behavior.

They all must believe interest rates are heading down even more.   Below zero.

Me?  I’ll stick with O.

• Terry Liebman