As one of the few American chroniclers of the still-obscure “yotai gap” phenomenon that has been present in Japan for a number of years, I read with interest a ZH post today that discusses it without using the term (LINK). Here is a graph lifted from that post (click on chart to enlarge):
I first discussed the yotai gap 1 1/2 years ago as part of my campaign to get readers to invest in zero coupon Treasury bonds rather than in stocks or other risk assets, in a post titled Yotai Gap to Provide Fuel to the Treasury Bond Bull? (LINK). The answer then was “Yes”, and even as Housing Bubble 2.0 currently appears to be in evidence (replacing the useless Internet Stock Bubble 2.0), the answer may- strangely- remain the same.
I do not want to discuss the larger thesis that “Tyler Durden” presents in the lengthy post from which the above graph is taken, simply to note that the yotai gap, namely the excess of bank deposits over loans made by the same banks, has now reached about $2 Trillion. It is reasonable in my philosophy to think that the banks have been encouraged by regulators to own Treasury bonds with these excess funds. After all, it is almost directly the Treasury that insures these deposits.
So long as the Fed QE’s, I am unpersuaded that there are not yet lower lows in long-term Treasurys ahead, even if their yields turn negative when adjusted for inflation.
Meanwhile, even as multiple bids for richly-valued housing become more common, the same rot that brought down the Bush (43) boom is being documented by the media. Bloomberg.com reports:
Bond Ratings Cuts Advance to Fastest Since ’09
Standard & Poor’s and Moody’s Investors Service are cutting corporate debt ratings at the fastest pace since 2009 as a global economic slowdown and record borrowing erode credit quality. The ratio of ratings downgrades to upgrades worldwide climbed to 1.85 this year from 1.23 in 2011, according to S&P data…
Europe’s second recession in four years and slowing global economic growth are helping to push a measure of corporate debt to earnings to a three-year high, Barclays Plc data show…
The increased borrowing and slower growth have increased the ratio of debt to earnings before interest, taxes, depreciation and amortization to 1.5 times at non-financial investment-grade U.S. companies, the highest level since 2009, Barclays analysts said in a Nov. 16 report.
That ratio is likely to increase in 2013 as companies facing a “deteriorating outlook” for the economy pursue transactions intended to boost stock prices, the analysts said.
Sounds familiar. It’s not just the last cycle that saw this. In the late ’90s, one of the reasons I got 90% out of the stock market in 2000 was that I had read that the Clinton era boom was the first in American history in which the credit quality of corporations had declined. Enron, Adelphia, WorldCom, etc. followed. Much worse was, of course, lurking one boom later.
What is the short-to-intermediate term course for interest rates even as the credit-dependent industries of housing and autos have taken the lead in the U.S. economy for now? Won’t this gigantic yotai gap inevitably lead to surging price inflation, pulling rates higher?
No, that may occur, but it is not inevitable. I saw three different surveys and reports today that suggested that consumer spending was restrained this holiday season, though to be fair, I saw one (Gallup’s daily polling) that suggested that the turn up in consumer spending is finally occurring. So we shall see what we shall see. As of the latest data, the U.S. was still experiencing the first baby bust since the 1930s. That decade was followed by low interest rates until 1958 and beyond, when the Baby Boom began putting real pressure on existing resources. So we may simply be shifting from a consumption “boom” coming out of the Great Recession marked by froth in retailing stocks to one in which consumption switches to building new homes and trading existing ones.
The banking system keeps the deposits when one person purchases a home from another, after all. Only the owner of those deposits changes (minus broker’s fees etc.). So the yotai gap can continue even if existing home sales soar.
Unlike last spring and summer, when the price of a zero coupon 30-year T-bond was a good deal lower than it is today (rates around 4.5% on those bonds were available), prices are now high enough (i.e., yields so low) that overt investment or speculation in them is not all so exciting, and the risk is commensurately greater. However, some people who are borrowing money for real estate investment, whether for a personal residence or for investment, may want to consider the purchase of these debt instruments as hedges. If another housing bust is coming, Japan-style, the bond “should” rise in price (decline in yield) from wherever it was when the bust got going (granted the starting yield may be higher than it is today); if the bond were to be a poor investment, then perhaps that would correlate with rising prices of the real estate asset.
The Treasury bond bull market has actually been choppy, going back to the early 1980s. It was a sort of boomus interruptus. In contrast, the NASDAQ boom that began at the end of 1974, coming out of the Great Recession of that era, continued virtually uninterrupted for just over 25 years. The estimable Jim Grant published a book in 1996 detailing the excesses of the NAZ. Thus he began writing the book no later than 1995, which was the first of five consecutive years in which the S&P 500 rose at least 20% a year, shattering the prior record of the late 1920s by two years. As we know, the NAZ clobbered the S&P in the second half of the ’90s. He was correct, but far too early.
Calling the top of a massive, long-term bull market is possible only in retrospect. Saying that makes me think of the much-criticized Greenspan assertion that bubbles cannot be identified while they are expanding. Is that the case now with interest rates? Are bonds in a bubble?
We may indeed be seeing a market top in bond prices, but key characteristics of a bubble are lacking.
Certainly there is no euphoria about this bull market, at least not publicly. CNBC does not cheer every time that interest rates tick down. No TBTF brokerages are aggressively selling zero coupon bond funds to breathless investors, supported by newsletters about how to profit from this no-lose investment. What could be an easier sell? The government guarantees you get your money back with interest, but you can cash out if prices rise and make more than your guaranteed rate. Sounds good to the fearful who wish to gamble just a bit, yes?
If the long bond rate were to drop from 3% to 2% in exactly one year, the total return from it would be about 25%.
Happily, such nonsense is not occurring. Quite the opposite.
Therefore I continue to watch the yotai gap expand and continue to grant all possibilities equal consideration under the laws of finance as they are interpreted in these modern times.