Doug Noland, author of the Credit Bubble Bulletin stated: “I’ve witnessed a lot of 'crazy' in my three decades of closely following various bubble markets….Yet nothing compares to the ongoing global yield collapse.”
Evidence to support Mr Noland's view is not in short supply: Italy issued a 50 year bond at 2.85 per cent and the deal was six times oversubscribed; a total of $13 trn in negatively yielding bonds account for 25 per cent of all global bonds, and 40 per cent trade to yield less than 1 per cent; some 89 per cent of Eurozone investment grade debt now trades at yields of 1 per cent or less and 27 per cent is in sub-zero land; plus, staggeringly, there are seventeen companies whose debt is junk rated and yet trade at negative yields.
What, you might ask, does this have to do with the performance of ‘value’ equities?
Very simply, it is my contention that the bubble in bonds has driven a bubble in ‘bond-like’ equities.
The chart below shows the incredible correlation between German bond yields and the relative performance of European growth versus value.
Source: Bloomberg July 10 2019
While many investors in these ‘growth’ businesses try to justify their all-time high valuations with a narrative that they are able to compound at high returns forever, in most cases that is simply not substantiated by the facts; Diageo trades at more than twice its long run average price to sales multiple despite posting a very ordinary growth rate of 2 per cent per annum for the past five years.
The evidence seems to suggest that the long march down in yields has been the primary driver of the performance of growth over value, and therefore it seems likely that a turn in these yields could be the catalyst for the reversal.
One commentator recently described ten-year bunds with negative 32 basis points as "good value" because he believes they will fall to negative 200 basis points.And if Christine Lagarde becomes the new head of the European Central Bank, he may well be right.
I would be the first to admit I have no idea when yields are likely to reverse but would simply observe that the universal consensus is that they can only fall from here despite being at 5000-year lows.
No one sees any threat of inflation in the future, everyone believes in the omnipotence of central banks to keep markets propped up and thus everyone believes bond proxy equities can only get more expensive and value equities can only get cheaper.
When consensus is this lopsided, experience tells me it usually pays to do the opposite.
Ian Lance is a fund manager at RWC
