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Madness or sanity?

King George III, born in 1738, reigned for 59 years, overseeing Britain through the upheaval of war, widespread social change and the industrial revolution. He was a monarch loved by his people, encouraging the arts and sciences and taking a genuine interest in the wellbeing of his subjects. England has a lot to thank him for. He famously started a new royal collection of books, a staggering 65,000 of which were later given to the British Museum and formed the nucleus of the British Library. By 1768, he had founded and part paid for the establishment of the Royal Academy of Arts. The King was also affectionately known as 'Farmer George', due to his keen interest and support of agriculture. Couple all of this with resistance to Napoleonic France; a happy marriage to his wife Charlotte which produced 15 children and a long life lived – dying in 1820 – and he should be remembered as one of our most famous monarchs. Sadly, this is not the case; instead King George III is remembered for something else – his madness.

George’s ‘symptoms’ started at the age of 50; he had abdominal pain, constipation, weak limbs, fever, a fast pulse and purple urine. Additionally he suffered headaches, visual problems, restlessness, confusion, delirium and fits. He was known to rip off his wig and run around naked in the royal palaces. Doctors declared him insane and towards the end of his life he was kept in a straightjacket and behind bars in Windsor Castle. These same doctors subjected him to everything “modern” medicine had to offer at the time. This included bloodletting, urine analysis and blistering, as well as purgatives such as rhubarb, senna, castor oil and antimony. Today, it is believed George suffered from the blood disorder, porphyria, which causes cramps, abdominal pain and seizures, similar to epileptic fits. It is also acknowledged that, during the King’s ‘mad episodes’, he exhibited features common to patients going through the manic phase of a psychiatric illness, such as bipolar disorder.

From Royal madness to policy madness? 

There is no doubt the King’s carers were trying to do the best for him, but their understanding of mental illness, let alone the remedies used, were primitive by current standards. Even today, both the medical and psychiatric professions acknowledge the need for better drugs and therapies, appreciating the course of action administered can be experimental. In all circumstances, there is a clear end goal to cure the patient, but by common acceptance – subject to the treatment applied - there may be some unwelcome side effects along the way.

Drawing parallels with the commitment of medics and psychiatrists to care for their patients, we have spent a large part of our time analysing the latest central bank statements. These key institutions are tasked with ensuring the relative health and wellbeing of the economies they oversee. The Fed, PBoC, BoJ, BoE and ECB are currently either in easing mode or signalling there is more support to come. Lingering underneath the surface, a much bigger story is playing out – namely, that some central banks are now operating at the limits of monetary policy. This in the context of slowing global growth and the perceived need for more stimulus. Against this backdrop, we must all ask ourselves, are the consequences of extremely low, or negative interest rates, properly understood and are some unwelcome side effects building in the system? In other words, will we look back on this as a period of central bank policy madness?

Here are some cases in point.

Who said bonds are boring?

The sharp fall in global government bond yields, triggered by the Fed policy pivot in January, resulted in the volume of bonds trading with a negative yield reaching almost US$17 trillion. Simple bond maths, of course, teaches us falling bond yields translate into rising bond prices, as the chart below reveals.

Australian Government 100 year bond


Source; Bloomberg, Kames Capital. As at 30 August 2019. Austrian Government 2.1% 20/9/2117.

This 100 year Austrian Government bond was issued in September 2017, with a coupon of just 2.1%, hardly an enticing asset to own. However, as European yields fell, this 2.1% annual cash flow has become increasingly valuable, resulting in the price of the bond (orange line – left hand scale) rising significantly in 2019. The year-to-date return to bond holders, as at 30 August 2019, was c.75%. Who needs to invest in the latest tech names when a good old Austrian Government bond has delivered these numbers? ‘Risk-free’ government securities are not typically held in portfolios to provide such returns, but ECB policies have ensured they have.

What if you can borrow, at no cost, for the next 5 years?

As a parting gift, Mario Draghi very blatantly handed the stimulus baton to European governments. A combination of a 10 basis points deposit rate cut to -0.50%; a resumption of QE at a rate of €20bn a month (80% of which consisting of government debt); and a pledge to maintain the size of the central bank’s balance sheet for ‘an extended period’ have effectively guaranteed the ECB’s bid in the market for Euro sovereign debt. This means – according to the economists at Gavekal – European yields will not rise for at least the next 5 years. Gavekal go on to say ‘The ECB’s effective commitment that it will not let sovereign bond yields rise over the medium term means that interest costs are going to disappear over the next few years as governments refinance themselves at zero or negative interest rates’.

This tonic of measures announced has purposely set the scene for Euroland governments – particularly those most indebted – to provide a fiscal stimulus to aid their faltering and unhealthy economies. Time will tell if Draghi’s medicine will effectively treat the ailing patient.

How about being paid to take out a mortgage?

It is not just the governments who are “benefitting” from preferential terms. In Denmark, homeowners are now being offered mortgages where the lending bank, in this case Jyske Bank, are paying borrowers to purchase a home. A negative yield curve, plus annual fees, still enables banks to borrow short and lend long, but weighs on their profitability. A dysfunctional banking sector is not a forerunner to a healthy economy, moreover, it runs the risk of sparking unusual consumer behaviour in terms of appetite to borrow, or possibly circumventing the banking system entirely.     

Source; Guardian 23 August 2019

This negative yield environment in Europe is also affecting pension funds’ and insurers’ ability to meet their obligations. From a societal perspective, this is not a situation that can be tolerated indefinitely and again may prompt disintermediation of these important pillars of modern economies.

Implications for portfolios 

If you had asked us at the beginning of this year whether government bonds would deliver the kind of returns they have, we would have responded “no way”. However, had we purchased the 10 year bund, gilt or US treasury on January 1st, they would have delivered 8.3%, 8.7% and 10.6% respectively. Those managers with more traditional strategic allocations or forced buyers of such securities, have participated in this rally. We chose instead to allocate to emerging market debt, macro and strategic bond funds, as well as liquid alternatives. Whilst the latter struggled, the rest captured comparable and respectable high, single digit returns.

So, where do we go from here and importantly, at current yields, does government debt offer any form of protection in a risk off scenario? We would caution against adding significant interest rate duration, i.e. a position that profits from falling yields, at this time. There are other ways to make money from fixed income allocations, including carry, relative value trades and currencies. Additionally, we continue to use gold, alongside trend following CTAs to provide crisis alpha, should markets take a turn for the worse. Whilst a 2020 US recession is not our base case, recent data points to a slowing global economy. Should fiscal stimulus not be forthcoming and/or inflation re-emerge in the US – forcing the Fed to reverse its easing policy – then equities and potentially nominal government bonds would find themselves under pressure.

Geopolitical tensions, alongside the long-term risks of deglobalisation and regime change, mean it is essential to build resilience into all our portfolios. We think of resilience as the ability to withstand different market conditions and recover quickly from drawdowns. Whilst defensiveness - which provides safety and preservation - plays a role in resilience, it is not the same thing. To quote Blackrock; “Resilience is not a short-term strategy, but rather an approach to building a portfolio that stays relevant throughout the cycle”. This is what we are endeavouring to do. Surely that is far from madness.

Dedicated to our friend, mentor and supporter, Stocky (1944 – 2019)


Please do contact us with any questions.

Julia Warrander and Russell Waite

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