Short of a Lifetime

Pfäffikon SZ, Switzerland – We are living in extreme times where there is no frame of reference extending into the past. Investors imagine themselves to be as Columbus on international waters. The earth turned out not to be flat, but round. The current monetary policy has pushed interest rates below zero and has lifted many markets to unprecedented heights, which – according to some – is nothing out of the ordinary. The same goes for the celebrating home owner, although he does not know why he is celebrating. I point the reader to the quality of the recent rally. The current financial situation appears stable, but everyone knows that this cannot be sustained over the long term.

Decoupling
Yesterday it became known that the Schweizerischen Nationalbank (SNB) had lost 30 billion Swiss francs by decoupling the Swiss franc from the euro. That is a lot of money for a small country. But the assumed-to-be-safe Swiss stockpile of gold lost a billion Swiss francs in value as well. Still, the SNB did not have a choice and the decoupling was a wise decision. The cheap outcry by Swatch CEO Nick Hayek we take at face value. The decoupling turned out to be the ideal buying opportunity for Swiss stocks, an opportunity we thankfully seized upon. The point I wish to make is that we are living in extreme times.

Short
Legendary bond investor Bill Gross called the 10 year Bunds the “short of a lifetime”. I suspect Gross is right. The Fed removed its contentious rate hike from the agenda this week. But still, the Fed will raise interest rates later this year, if only to prove it can. An increase of 0.25% will barely affect US businesses and they will be able to carry the burden. It is more important to note that history shows us the Fed is tenacious in its changes of monetary policy. That is a fact you – as (bond) investor – should take note of.

Swaps
Pension funds, meanwhile, have their fingers caught in the door. The requirements are increasing while interest rates continue to drop. This is a deadly combination which leads to premium increases. In the fight against diminishing coverage rates pension funds have increasingly been opting for special financial instruments. It is a development of which yours truly is not a fan, but that is a separate discussion. Long-term swaps are an example of such an instrument. Many individuals in SMBs are also familiar with the negative character of the swap. The value of the pension funds’ swaps, however, have risen to unprecedented heights.

Now that one of the most respected bond investors is shorting his beloved investment class, it is perhaps a good moment for pension funds to cash out their long-term swaps. If pension funds were to all do this simultaneously, interest rates would surely increase. I for one would not wait to see if Mr. Gross is right with it being a “short of a lifetime”. We are living in extreme times, do not be mistaken about that.

It remains for me to wish you a good weekend.


Jan Dwarshuis is a senior asset manager at Thirteen Asset Management AG, where he is responsible for the Thirteen Diversified Fund. Dwarshuis writes his columns in a personal capacity and is not paid for them. Nor is he paying for his columns to be placed. Professionally, he holds positions in major European, American and Russian stock funds. The information in his columns is not intended as professional investment advice or a recommendation to make certain investments. At the time of writing, he has no position in the above shares and has no intention of doing so in the next 72 hours.