The bond markets are speaking to us — yelling loudly if you believe the FT.
I have been relaying the gloomy financial prognoses from the FT this week. Two new essays — one by Richard Milne and Michael MacKenzie, the other by Martin Wolf — continue in this vein. Milne and MacKenzie wonder if the drop in the yield of 10-year US Treasury and German Bund notes to under 2% marks the advent of a Japanese-style swoon in assets. Yields on 10-year bonds are now arguably negative in real terms — meaning that investors are so pessimistic about other asset values declining over the next ten years that they will pay the government to hold their money and promise nominal stability. That is, unless bond investors are counting on significant and sustained deflation — which is just what Japan got — so that in the longer run they will get positive real yields, even at these low rates.
So the bond market seems to be telling us to expect a long-term deflation in all asset values – real estate, commodities, equities. While many would think this is impossible, the example of Japan shows it is not. And recall that Japan experienced this long (14 years and counting) stagnation in equity and property values despite rapid growth in its major trading partners: China, Korea and the US. America and Europe will face substantial but slowing growth in China, and stagnation in their other major partners, namely each other. One has to hope that Canada, Latin America, and Africa will provide some boost to the world economy, and that the coming slow-down in China is offset by some acceleration in India. Otherwise the the world economy will stagger to a shuddering halt in the near future.
Wolf is a bit more optimistic, as he argues that the bond markets are sending a slightly different signal — borrow and borrow some more (it is cheap!) to make investments that will produce future growth. Although what those investments are seems unclear, or more banks would be lending to those seeking to make those investments. Government stimulus could still help matters (see my upcoming post on Thursday — “More Water?”) but the political zeitgeist seems dead-set against that approach. With Germany’s finance minister and Britain’s chancellor preaching austerity, and US actions hamstrung by a majority in the House that seeks to shrink government, politicians seem intent on replicating the 1930s.
So, my guess is that growth is dead. Get used to it.
Re your query where to invest: arbitrage works well. Borrow in dollars, invest in good emerging markets and shed tears of shame all the way to the bank.