Boredom, Yield and Paper
(Bloomberg View) -- Nothing is happening.
It is so boring, go ahead and take the next two weeks off:
The past 30 days have been the least volatile of any 30-day period in more than two decades. Only five days during the most recent stretch saw the S&P 500 move by more than 0.5% in either direction, the lowest since the fall of 1995.
Really you didn't have to be here the last two weeks either:
“Last week and the week before, you had to make sure your machine was actually on because it was flashing so infrequently,” said Jared Woodard, a strategist at Bank of America Merrill Lynch.
Obviously the counterpart to boredom is terror, and with nothing better to do, people have plenty of time "to worry that a market storm may be brewing, as peaceful periods in the past have frequently ended in sharp corrections." But implied volatility for the next few months also isn't particularly high: The VIX volatility index, which sort of measures market expectations for near-term volatility, is near its lows, and "the gap between the VIX and realized volatility is roughly in the middle of its range from the past 20 years." The market is boring, and the market for boredom implies similar boredom as far as the eye can see. Of course the market for boredom has been wrong before, and every new panic is a surprise.
One reason for the boredom is central bank policies. People talk about the "Yellen put," which traditionally refers not to an actual put option but to an implied promise that if asset prices fall, the Federal Reserve will become more accommodative to prop them up. But there is also the possibility that the Fed's current low-interest-rate policy has conjured up an actual Yellen put, as investors desperate for yield are getting it by selling stock index puts, and that supply of puts insures other investors against market drops and keeps implied volatility low:
In a research note Monday, analysts at Bank of America Merrill Lynch suggested that implied volatility is so low because the market is overflowing with sellers of these contracts, who are out to collect whatever premiums they can. Pension funds in Hawaii and South Carolina are known to be doing this.
We talked a little about this yesterday. You can sort of imagine that the Yellen put has been contracted out to those pension funds: If asset prices fall, the first line of defense for the market -- the thing that will step in to keep prices up -- is not the Fed, but that Hawaiian pension fund that agreed to buy stocks if the market falls. Of course that pension fund doesn't think of itself as the market's first line of defense. It more or less just trusts that the Fed will keep prices up and it won't ever get hit on its puts.
On the other hand, yesterday the VIX also had its biggest one-day gain since June, up 0.93 points to 12.27, which is still not very much, and which marks "30 sessions without a move of 1 percent or more on a closing basis."
There's no yield.
Things are bad for pensions:
“It’s existential. That’s the one-word summary of the scale of the challenges,” says Alasdair Macdonald of Willis Towers Watson, an actuarial consultancy. “You can pull different levers, but the declines in rates is an existential problem for the entire pensions system.”
Low interest rates also lead to higher valuations on equities, which make up the bulk of most pension funds’ portfolios. With stocks more expensive, expected future returns are lower, making the problem of meeting pension promises even more severe.
“It’s scary and it’s surreal,” says Carsten Stendevad, who heads ATP, the $110bn national Danish pension plan. “First, if you’re in the business of offering annuities, your product just became very expensive to produce. But secondly we can see that the impact of QE is affecting other asset classes as well. That’s the scarier part. There’s nowhere really to hide.”
You can conceptually separate this into two problems:
- The idea of a pension is to reallocate real resources from people who are currently working to people who are currently retired. This works well as long as working populations and productivity are growing: If there are more working people than retired people, and if the working people are producing ever more stuff, they can make enough stuff to provide the retired people with a high standard of living. But as retirements last longer and populations grow more slowly, fewer working people have to support more retirees, and as productivity growth slows, those working people have less stuff to give to the retirees.
- Some accounting stuff about nominal interest rates and asset prices.
Loosely speaking, central-bank policies -- and, really, pensions' investing decisions -- can address problem 2. Problem 1 is harder.
Elsewhere in pervasive low-grade panic about low yields, Citi's Matt King "echoes a group of fund managers who say central banks’ stimulus efforts are distorting the way global markets function." And leveraged-loan covenants are getting weaker as "there is too much money chasing too few loans." And investors are buying stocks with reliable dividends as a substitute for bonds. They're even buying Argentine corporate bonds, though without much enthusiasm:
Argentine companies are returning to global markets as bond investors travel the world in an effort to pick up yield at a time when 10-year U.S. Treasury debt has been paying around 1.5%, and bonds in other parts of the developed world offer even less. This search has taken some investors as far as Indonesia, where government bonds have offered yields around 7%, and others to even more obscure markets, such as Mongolia, which this year sold bonds with a yield of 10.875%.
But the track record for Argentina’s corporate-bond sales has been mixed. Out of nine deals this year, two had to be pulled or cut back.
Even this is I guess a yield story, as investors are moving money from negative-yielding paper into zero-yielding gold in vaults:
The stash of gold, silver and gems stored in the vaults and safe deposit boxes of Malca-Amit in Singapore has jumped almost 90 percent in the past year as wealthy investors seek a refuge in a world of negative interest rates, stagnating economies and political uncertainty.
I mean, you have to pay rent on the vault, but that's still better than the yield on 2-year Bunds.
A lot of public-choice discussion of the financial industry focuses on the idea that the financial industry has monolithic concentrated desires (less regulation, etc.), and can lobby for those desires, while the interests on the other side (consumers who would be protected by more regulation, etc.) are too diffuse to fight back effectively. Who will stand up to the financial industry on behalf of the American consumer? Hahahaha the answer is paper companies:
The president of Twin Rivers Paper Co. has zeroed in on something a bit closer to home: stopping a U.S. Securities and Exchange Commission plan that would spur more investors to get mutual fund reports online.
“After the nightmare of the meltdown in 2007 where millions of shareholders watched their holdings evaporate, Wall Street must remain accountable with paper statements and printed information,” Winterhalter wrote to the agency after it made the proposal last year.
It's an amazing story about the path-dependence of regulation. Imagine if the paper companies came to Congress in 2016 and said, "you know, mutual fund companies should really be required to print a screenshot every time they look at a stock price, for archiving purposes." Everyone would laugh at them. You can't just ask Congress to require companies to use more paper, for antiquated purposes, because it will be more profitable for you. But you can ask Congress to require companies not to use less paper, for similarly antiquated purposes, because using less paper would be less profitable for you. Asking to keep things as they've always been never seems like that big of an ask.
The mutual-fund companies are fighting back, though it is awkward for them since, you know, they're the ones writing the reports:
The Investment Company Institute, the funds’ trade group, countered that the documents can be as long as 651 pages. “While they contain important information, many shareholders likely find the contents and length of these reports quite daunting,” the ICI told the agency in March.
Obviously no one reads mutual fund shareholder reports -- I throw all of mine away unopened (not investing advice!) -- but imagine being the mutual-fund company lawyer who wrote those 651 pages. Actually, I guess it's possible that some mutual-fund lawyer wrote both her company's unread annual reports and her company's comment letter telling the SEC that those reports are a waste of time. And then went right back to writing the reports. It is too grim to think about.
ISS and pay.
Here is a story that puts some of the blame for market short-termism on Institutional Shareholder Services, the proxy advisory firm:
In its recommendations to subscribers, ISS compares a company’s CEO pay and its total shareholder return -- the change in stock price plus dividends paid -- to those of competitors. A mismatch between pay and three-year relative stock performance can result in ISS urging clients to vote against the company’s pay plan and reject directors serving on the board’s compensation committee.
But that metric can be gamed:
Linking CEO pay to stock return can also encourage managers to focus on short-term gains rather than building the business for the long haul, according to William Lazonick, co-director of the Center for Industrial Competitiveness at the University of Massachusetts at Lowell.
“You’re incentivizing executives to do whatever they can to get the stock price up,” he said.
Evidence of corporate America’s efforts to buoy share prices, sometimes at the expense of a wider vision, is everywhere.
One thing that is going on here is that anything that is measured will be gamed. You want to have some quantitative metric for rewarding executives for good performance and punishing them for bad performance? That metric will be gamed. The right way to reward executives is to know them and the company really well, to have a deep nuanced feel for what kind of job they're doing, to back up that feel with extensive data analysis, and then pay them based on that holistic assessment. But who has time for that? These are public companies with diverse public shareholders. Of course those shareholders are going to rely on ISS, and of course ISS's metrics will be simplistic and manipulable.
The other thing that is going on here, though, is that total shareholder return actually seems like a pretty good metric? I mean, it aligns incentives, obviously enough; total return is what the shareholders want. But it also seems hard to game, compared to, like, some accounting measure of profit growth or whatever. Despite the short-termism critique, total shareholder return measures the increase in the long-term value of the company, as perceived by the stock market. (Stock prices discount all future cash flows, don'tcha know.) The market can be wrong, of course, but on the other hand the shareholders are the ones paying the managers, so why shouldn't their perception of value be the one that counts? Replacing total shareholder return with some accounting-based measure wouldn't eliminate gaming or short-termism, but it would mean that managers could get paid based on numbers that they control (financial statements) rather than numbers that the shareholders control (the stock price).
What do you do after going to the Olympics in a, let's say, non-revenue sport? The obvious answer is to become a retail financial adviser:
After winning a silver medal in Taekwondo at the 2008 Beijing Olympics, Mark Lopez's training partner suggested he looked to Wall Street for his next career.
"I can't kick forever," Lopez recalled telling himself before he joined UBS AG as a financial advisor in Houston in 2011.
It's true, Wall Street does offer the closest thing to the sensation of punching someone in the face that you can get in a desk job. It goes almost without saying that "In his picture on the UBS website, he's holding his silver medal." I feel like 50 years ago the paradigmatic ex-athlete job was running a car dealership; now it is being a financial adviser to high-net-worth clients, and I would read a sociological study on the shift. Surely it is in part about the move to a post-industrial economy, and the rising share of the economy taken up by the financial industry. But also, a car salesman is mostly selling a car; a financial adviser is more purely selling himself. It just seems like a more efficient way to transform social capital into money, to extract value from celebrity, or micro-celebrity, or at any rate a cool personal story.
Using hand-collected data from individual Census records on the wealth and income of managers’ parents, we find that managers from poor families deliver higher alphas than managers from rich families. This result is robust to alternative measures of fund performance, such as benchmarkadjusted return and value extracted from capital markets. We argue that managers born poor face higher entry barriers into asset management, and only the most skilled succeed. Consistent with this view, managers born rich are more likely to be promoted, while those born poor are promoted only if they outperform.
Eventually there will be a conference where a central bank governor just stands up and shouts "blockchain" for 25 straight minutes, but for now I will have to content myself with this article:
Bank of Japan Governor Haruhiko Kuroda said the central bank may apply financial technology, or "fintech," to its operations in the future given its growing influence on global payments, settlements and financial services.
The BOJ is ready to lead research and analysis to promote fintech in Japan given it has "various implications" for central banking, Kuroda told a seminar hosted by the bank on "fintech" on Tuesday.
I mean, I'm sure he was more substantive than that. I'm sure he didn't just stand up and say "we're gonna get some more fintech up in here, need some of that good fintech, just applying the fintech, thinking about all those various implications of fintech, fintech fintech fintech." That would be silly.
People are worried about unicorns.
In India, people are watching out for "soonicorns," which are ... I mean, you can guess, obviously. "Tech startups that are likely to see follow-on funding, and have the potential to scale to billion dollar companies." It is kind of a low bar. People complain sometimes that startups stretch for the "unicorn" designation, agreeing to funding rounds with bad structural terms just so they can get the headline billion-dollar valuation that lets them call themselves "unicorns." But you can call yourself a "soonicorn" whenever you want. Register a domain name, print some t-shirts, and just confidently assert that one day you'll be a unicorn. Who can prove otherwise? Then just swallow the "s" a little in pronouncing it and you're practically there.
People are worried about bond market liquidity.
I mentioned the mixed results of Argentine bond deals above, but the problem does seem to be in part about liquidity:
“It’s very difficult to trade around these credits. There’s very little liquidity,” said Jason Trujillo, a senior emerging-markets analyst at Invesco in Atlanta, which has $779.6 billion under management. “Investors are not willing to go into these small risky deals.”
“People have different risk appetites, but in this environment, I put a large premium on liquidity,” said Nishant Upadhyay, head of global emerging-markets debt at HSBC Global Asset Management, which has $20 billion in such debt under management.
You would think that all the desperate yield-hunting would make people chill out about liquidity a bit. In a world where people will move from investment-grade to junk, or from developed to emerging-market sovereigns, or from bank accounts to a vault full of gold, or even from bonds to stocks, for a few extra basis points of yield, shouldn't they be happy to take a yield premium to buy somewhat less liquid bonds?
Elsewhere: "China close to launching credit default swap market."
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