In the last months we have written about bubbles, bonds and the shifting balanced portfolio model in an inflation prone environment. We have a unique mix of variables in play today unlike any other time in history. Zero to 1.6 percent bond yields that are unlikely to cover the rate of inflation, so in essence, negative yielding. There is little to no room for bond prices to rise so the next logical question is: What's the economic rationale for holding bonds? For most institutions, at this juncture and in a climate of forseable low interest rates per the Federal Reserve, bonds are looking increasingly like a losing proposition.
As Christina Lagarde, the head of the ECB (European Central Bank) recently commented "Higher market interest rates pose a significant risk to financing conditions (e.g. a recovery). Rising bond yileds could lead to premature lightening" of credit conditions which of course would hamper yes, you guessed it, a recovery. COVID has walloped the Global Economy, created sky high unemployment and generated a bigger wealth divide. The answer per the Federal Reserve and ECB is continued stimulus and low, exceedingly low, rates.
The Bond Dilemma unless you are Microstrategy
As we have discussed holding bonds for most institutions is a losing proposition in the current and forseeable climate. That is, unless you are Michael Saylor of Microstrategy where issuing convertible bonds at close to zero interest rates and re-investing the proceeds into a finite asset with limited supply such as Bitcoin becomes a strategic bet that has significant potential upside while the downside is mitigated. How many other companies will follow in his footsteps. It's likely to grow. The Bond Dilemna is no doubt causing the financial establishment such as Mass Mutual to start allocating funds to Bitcoin. How many Insurance companies will follow? We are guessing that a lot more will do the same becuase holding bonds is, yes, a losing proposition in this climate.
The Stock Bubble Dilemma
We have covered the Bond Dilemma and we have touched on the current stock market dilemna. Valuations are at record highs both in terms of Price to Sales and Price to Earnings ratios. If money wants out of bonds where can it go? Stocks, digital currencies, cash are other options. Digital currencies or crypto currencies are still not well understood but that is changing. Cash is undesirable in an economy facing inflationary pressures. Stocks become the option of choice and so portfolio wieghtings will inevitably lean more to stock allocations which in turn creates the stock bubble dilemma. Stocks are already inflated by traditional measures. We may not be at the year 2000 Dot Com Bubble Highs just yet, but we are getting closer.
As mentioned, digital currencies are still foreign to many investors and institutions but that is changing. With Tesla, Micro Strategy allocating large treasury portions into Bitcoin and with Coinbase (the largest digital currency exchange in the USA) filing to go public at an estimated $70 Billion market cap this is changing quickly.
Next week we will continue to look at the risk environment that wealth management firms are having to navigate.