Barron\'s - 30.09.2019

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30 BARRON’S September 30, 2019


CURRENT YIELD n By James Grant


A Rendezvous With Zero?


Yields of Austria’s 100-year bonds are falling. What happens when the market turns?


IN 1961, READER CHARLES


Calvert stepped off the


USSShangri-Laandinto


civilian life at the Na-


tionalSavingsandTrust


inWashington,D.C.Lit-


tledidthetyrosecurities


analyst realize that interest rates were


poised for a 20-year lurch to the upside


followed by a multigenerational break to


the downside.


He realizes it now. Like many who


cameofageduringtheinflationofthelate


20th century, Calvert has had the devil’s


own time adjusting to the era of subzero


percentbondyields.Hecan’tgetitoutof


his head that the borrower ought to pay


the lender, not the other way around.


Evenso,almost$15trillionworthofse-


curitiesworldwidearepricedtoyieldless


than nothing. Additional trillions, junk


bondsincluded,yieldnotmuchmorethan


that inconsiderable figure. A Missourian,


Calvertapproachestheinterest-ratesitua-


tion with native skepticism. He writes to


updatethestatusoftheAustriancentury


bond, the double-A-rated, euro-denomi-


nated2.1sofSept.20,2117,thatwerefea-


tured in this space on July 5.


You may recall the yield attached to


thatexotic,ultralongissue—amere1.08%.


Thiscolumnrolleditseyes.Solittleforso


long? Your columnist, age 73, predicted


that he will be in better shape come the


2117maturitydatethantheinvestorswho


doggedly buy and hold those mispriced


pieces of euro trash.


But a funny thing happened on the


road to ruin. In not quite three months,


that 1.08% yield to maturity has fallen to


0.72%.Thepricehasreciprocallyrallied—


no,thewordisleapt—to197.7from161,up


by22.9%.You’dthinkthatthebondwasa


stock.


Intheirprosperity,thebondbullshave


beguntoholditagainsttheweekendsthat


themarketisclosed.SomeexpecttheEu-


ropean Central Bank to keep buying


bondsatever-higherprices,theAustrian


centuries included. Others hope for still


more radical policy assistance. Just the


otherday,MarioDraghi,theECB’soutgo-


ing president, admonished his soon-to-be


former colleagues to keep an open mind


about modern monetary theory, the doc-


trineoflimitlessmonetaryaccommodation.


It is limitless, at least, until an inflation


problemsurfaces,buteventhenacompli-


ant central bank wouldn’t raise interest


rates.Rather,thegovernmentbehindthe


central bank would raise taxes.


Notthatanacceleratingrateofinflation


appears imminent—low birthrates, crush-


ingdebts,anddigitalefficiencieswillseeto


that. “Low inflation,” declared New York


FedPresidentJohnWilliamsonSept.4,“is


indeed the problem of this era.”


Yes, the measured rate of inflation in


Austriais1.5%,morethantwicewhatthe


centurybondsyield.Butastothatdatum,


as well as other fundamental consider-


ations—for example, the strength of the


euro and the creditworthiness of the for-


merAustro-HungarianEmpire—themod-


ernbondmanagermaybeagnostic.Ifyou


run an index fund, you buy the securities


in the appropriate index, no analysis


required.


Anyway, as the bulls see things, every


euro-denominatedyieldstillquotedinpos-


itive figures is a candidate for a rendez-


vouswithzero.Justimagine,theysay,that


today’s72basispointyieldtomaturitybe-


comes tomorrow’s 50 basis point yield to


maturity.Ifso,theAustria2.1swouldrally


to223.7from197.7.A25basispointyield


to maturity would lift the price to 260.6.


And a 0% yield to maturity—well, why


not?—would deliver a price of 306. Bond


folkusedtojokeaboutanimaginedzero-


couponperpetual,asecurityprovidingno


current yield and never maturing. A bull


can dream that Austria might start the


ball rolling.


Calvert leaves the bulls totheirimag-


inings. His conservative approach is the


one that Ben Graham himself prescribed


for investors in senior claims. Because


fixed-income securities pay you par and


thecoupon,atbest,cautionisparamount,


said the father of value investing. Yes,


Graham did write before the advent of


quantitativeeasingbutnotbeforethein-


vention of common sense.


Anyway, our reader muses, imagine


that yields go up, not down, and that the


firststopis1%,or100basispoints,versus


today’s72basispoints.Youwouldthenbe


looking at a drop in price to 168 and


change from 197.7. Nothing you couldn’t


recover from, an optimistic holder might


consolehimself—onlyrecallthepotofgold


at the 0% mark.


But,Calvertproceeds,assumethatthe


1%marketyieldnowbecomesa2%yield,


alongwithacorrespondingpriceof104.3.


Impossible? It was possible enough in


2017,whenthebondscametomarket.Be


thatasitmay,wearenowtalkingabouta


47% plunge in principal value.


Long-dated Treasuries fetched 3.90%


or so on Calvert’s first day of work 58


yearsago,soheseesnothingoutlandishin


theprospectofareturntothatnot-so-ele-


vated yield. At 4% on the nose, the 2.1s


would command a price of 53.6, a loss of


almost 73% from the current level.


At the alpine reaches of 6%, our


reader’s analysis concludes, the price


would fall to 35, indicating a loss of


slightlymorethan82%.Itisadrawdown


onlysevenpercentagepointsshyofthein-


famous 1929-32 plunge in the Dow Jones


Industrial Average.


Calvert claims no gift of financial


prophecy. He says he sold his bonds


many years ago, never imagining just


how far the bull market could carry. He


tips his hat to Lacy Hunt and Van Hois-


ington, prescient bulls at Hoisington In-


vestment Management, but says he is


happier husbanding cash “in plain-vanilla


money-market funds, available to take ad-


vantage of any meaningful corrections in


the stock market.”


“Regardingbonds,”ourcorrespondent


adds, “my policy, to quote from the Fed,


withaverydifferentmeaning,isto‘have


patience’ and wait for a return to a time


when bonds will sell to provide a decent


real rate of return.”


Besides the 2.10s of 2117, Austria is


famous for Sacher torte, Mozart, and a


theory of the business cycle having to do


withtheunintendedconsequencesofcock-


eyedinterestrates.ButitwasanEnglish-


man,LordLiverpool,whoanticipatedthe


Austrian economists in that analysis and


topped them in concisely expressing it.


Here,courtesyofthefinancialcommenta-


torMartinHutchinson,isLiverpool’sun-


derstateddictumaboutthecorruptingef-


fects of loose monetary policy in a fiat


currencysystem:“Thetendencyofanin-


convertiblepapermoneyistocreateficti-


tious wealth, bubbles, which by their


bursting, produce inconvenience.”


Stand by for inconvenience.


JAMESGRANT,founderandeditorofGrant’sIn-


terestRateObserver,istheauthorofBagehot,


thelifeandtimesofthemuseofmoderncentral


banking.


The 100-Year Bet


WiththeEuropeanCentralBankbuyingbonds,Austriancenturybondshaveseentheirprice


surgeover20%,andyieldstumble.Butthatmathcouldeasilyreverse.


Source:Bloomberg


Austrian 100-Year Bond


Oct. ’18 Dec. Feb. ’19 April June Aug.


100


125


150


175


€200

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