Corporate and Government Bonds - All Risk from now on.

It is possible that a few Trobriand Islanders, some Siberian indigenous natives and even some saffron-robed monks perched high in the Himalayas may have missed the news - but the rest of us are only too painfully aware of the financial troubles of the last three years.

My first observation is the staggeringly comical ability of some "think-tanks" to produce research such as this -  http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8040090/UK-tiptoeing-towards-Japan-warn-consultants.html  - where the reasoning is exactly that which was eschewed during the boom years. I am reminded of the words printed on rear-view mirrors in the USA (where they are obviously not bright enough to think for themselves) that "Objects seen in the mirror may seem closer than they are". So it is apparently with financial crises. Despite the 4-sigma Black Swans being just that, it seems that all financial commentators are now permanently living in Western Australia. (For the hard of understanding, this will explain my reference - http://en.wikipedia.org/wiki/Coat_of_arms_of_Western_Australia  ).

Whilst happily ignoring the "fact" that the metrics recently rediscovered for financial prudence are far from new and that moves were in place - Basel 2, 3, 432 and so forth - to use (while blissfully ignoring) such metrics, it is now so clear to these sages that we are doomed to undercapitalised financial institutions and multiple-dip recession. To quote the greatest sage of all, Frankie Howerd, "Woe Woe and thrice Woe!!"

Our political masters have dealt with the crisis by injecting into the system so much money that interest rates are functionally zero or negative in the wholesale market. I contend this was right and the only course of action. The major banks have accepted this largesse with glee and stuffed their balance sheets with this free money whilst keeping retail rates sky-high and feeding large quantities back into their investment banking activities, what Vince Cable calls "Casino Banks". Almost the only positive side-effect has been to allow larger corporate borrowers to refinance at wholesale (i.e. almost zero) cost. As a result both Government Bonds and Corporate Bonds are trading at record highs.

This situation is unsustainable. The only two end-game scenarios (and they may well be two faces of the same coin) are either to suck back the surplus liquidity once the world economy is adjudged to be "safe" or to attempt (which it seems is covertly happening already) to depreciate a currency enough that the resulting inflation acts as a counterbalance. Timing is everything here - and is it really possible to trust Central Banks or Governments, with a tradition of centuries of acting to late, to get it right. In any case - inflation here we (eventually) come.

Whether one believes that we will all be double-dipped in the brown and smelly stuff or that things are painfully inching back, the time can hardly be more that 2 years away before the punch-bowl is taken away from this party and rates start to rise rapidly. Please note. I make no issue with whatever may befall in the interim.

With the exception of the insane mentality that promotes Gold as an "investment", there are fewer safe havens than Government Bonds and I would even argue that some Corporate Bonds provide more security in that supra-nationals are a spread of risk against sovereign default. Even so, there is really little or no more juice to be sucked from the Orange of yield and my fear is that Mr. Market,  with his love of discounting future events, will soon see over the horizon to the gloomily-lit downlands of higher interest rates.

Where does that leave us? Probably the 4%+ yield on major indices (avoiding the risks and rewards of stock-picking - I am talking indices alone here) in equity markets. The fear/greed ratio seems to be so high these days that sell-offs of an illogical nature (or, in the interests of even-handedness, equally silly rallies) and major short-term moves can reasonably be expected. Of course this argument will also be subject to the idea of markets discounting forward events, but historically inflation has been far less destructive of equity than bond markets.

Dum Spiro Spero