everyone hates duration

good morning. A federal judge has blocked Kroger’s proposed purchase of Albertsons. Although the incident is not yet over, this certainly worsens the outlook. The stock prices of both grocers fell only slightly, showing how few investors believed the merger would go through in the first place. Is anyone still betting on it? Please contact us via email: [email protected] and [email protected].

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It’s outlook season, when Wall Street’s buy-side and sell-side strategists release their predictions for 2025. An interesting question is how confident strategists are in their predictions. Outlook documents are sales tools, designed primarily to boost your business now rather than look smart 12 months from now. Still, they do add flavor to Wall Street’s consensus mood. And there are two major factors in the current mood. The first is to continue investing in U.S. growth stocks for a long time. Second, although less common, is to avoid the long end of the Treasury curve.

The pillars supporting the latter point are reasonable enough. The US budget deficit is getting worse and is likely to get worse. This creature, a bonded vigilante, has been dormant for a long time and must one day awaken. At the same time, the risk premium (the additional yield investors are paid over expected future short-term interest rates for holding long-term government bonds) is historically low. Finally, the inflation monster may not be dead yet, and Donald Trump’s policy proposals could feed it.

For example, here are Mark Seidner and Pramol Dhawan of fixed income manager Pimco.

It is difficult to predict sudden market reactions to long-term trends. There are no organized vigilantes who act when certain debt thresholds are reached. . . (But) we are already making gradual adjustments in response to the increase in the U.S. budget deficit. Specifically, it is less likely to lend to the U.S. government at the long end of the yield curve.

AllianceBernstein summaries fit neatly into spreadsheets.

Structural risk. Short-term premium, inflation volatility. Reduced diversification. The outlook is for bond issuance to exceed bond demand.

BlackRock Investment Institute says:

It is unlikely that U.S. outperformance will extend to government bonds. We tactically undervalue long-term government bonds, as we expect investors to demand greater compensation for the risks of holding long-term government bonds given persistent fiscal deficits, persistently high inflation, and increased bond market volatility. I’m doing weights.

and so on. This is all reasonable. Yields on 10-year and 30-year bonds are nearly indistinguishable from the 4% available in cash, so it would take confidence that rates will fall for them to move far off the curve. And confidence is in short supply amid the biggest inflationary episode in decades and a new government sending mixed messages on policy. On top of that, the recent drop in duration performance is hard to forget. If I ditched bonds and bought stocks five years ago, I don’t regret it.

JPMorgan Asset Management is bucking the trend a bit, arguing that there is room for the 10-year Treasury yield to fall as growth and inflation take hold.

The 10-year rate has already fallen 1% since its peak of 5% in mid-October, but we think there is room for long-term rates to fall further while the Fed holds policy, especially if growth continues. is thinking. And inflation continues to trend downward. This suggests that investors should consider getting rid of cash and extending duration, as falling yields could significantly increase the price of longer-maturity bonds.

“This suggests investors should consider” is not exactly a table-banking recommendation. But in the current environment, this is what duration bulls look like.

Unhedged’s friend Edward Al Hussaini of Columbia Threadneedle makes a more focused argument about the time period. He sees this as a way to protect large stock gains. Rebalancing from equity to duration is a bet that the yield on duration will exceed cash, meaning that interest rates will fall further, or at least not rise completely. But more important is the bet that bonds will rise even as stocks fall. This is more likely to be the case if inflation is low and stable.

Starting at 4% nominal, 2% real yields, assuming inflation won’t be where it is in 2022 and stock-bond correlation is likely to be negative, duration is attractive for now. Become.

I asked Al Hussaini whether investors were warming up to the idea. it’s not. “Nobody likes duration,” he says. “It’s difficult to have conversations with clients who are making a lot of money not only in stocks but also in money markets and gold.”

China

The Politburo, the Chinese Communist Party’s top political organ, announced on Monday that it would change its monetary policy guidance from “prudent” to “moderately accommodative.” Investors were excited. The Hang Seng index rose 3%, and the Shenzhen and Shanghai CSI300 index rose 1.3%, reversing a temporarily volatile decline from September’s gains.

There is reason to believe this is a big problem. Depending on your point of view, monetary policy is too tight. According to Arthur Kroeber and his team at Gavekal Dragonomics, real interest rates are slightly higher than GDP growth. China is battling deflation and low growth, but the situation is reversed.

Politburo announcements often provide the best insight into Xi Jinping’s thinking. If he is hinting at the need for more work on monetary policy, it suggests that the long-awaited fiscal stimulus may finally meet investors’ high expectations. Similar monetary policy stances have preceded stimulus measures in the past. The government adopted a “moderately accommodative” stance after the Great Financial Crisis, which resulted in a RMB4 trillion ($568 billion at the time) stimulus package.

But at the risk of putting the cart before the horse, this may be another case of much ado about nothing, especially on the monetary policy front. The People’s Bank of China has lowered all three major policy interest rates this year. With deflation concerns mounting, there is little choice but to lower stock prices.

The transmission of monetary policy to the economy is also relatively weak because demand for credit and borrowing is low. And ultimately, China’s problems are structural, not cyclical.

When we see meaningful stimulus from China, we will believe it.

(writer)

A book I read often

A great day in Harlem.

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