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Posted by on Jun 22, 2016 in ETF Strategist, Market Insight

Of Supernovas & Deflation

Of Supernovas & Deflation

By Roger Nusbaum, AdvisorShares ETF Strategist

 
Barron’s was chock full of interesting quotes and comments over the weekend in addition to the bizarre cover story on watches…as in wrist watches.

Bill Gross is concerned about the $10 trillion in global debt trading at a negative yield. Obviously markets are in uncharted territory with this and it is right to be concerned about some sort of negative consequence. Gross thinks it will explode like a supernova.

A former colleague emailed me to ask what would happen to bond ETFs in the face of some sort of meltdown triggered one way or another by the myriad of distortions currently at play, or potentially at play in the bond market. Based on previous, albeit short lived, events we probably have a good idea. Market prices could trade away from IIV’s (ETF equivalent of NAV) but still trade. In that scenario you’d be able to get out might feel hosed in doing so. Of course you could just wait few days and probably trade closer to IIV. A fund could stop the creation/redemption process which could also cause a large divergence between the market price and the IIV but again, in that scenario you’d be able to get out.

I would argue that selling right into the teeth of one of these events, like a day or two after the Lehman bankruptcy, is unnecessary for just about every market participant for the simple reason that this would be the epitome of panic selling.

I am less concerned with trying to predict anything so much as trying to be aware of the risks for any asset class that are in the portfolio. ETF.com recently had an article titled Top Performing Bond ETFs Pay No Income. The types of funds in that article are probably at risk of a huge decline if Gross is right. A bond fund that can go up 20% in five and half months can probably go down by that amount in a much shorter time period.

There was also an interview with Russell Napier who hung his own shingle after working at CLSA. He’s pretty bearish on a lot of things including having “been bearish since 2011 on equities and commodities, and expects deflation to hit developed markets.” So he’s missed a little upside and a few of the comments on the article were critical and skeptical of the conclusions he draws about the “helicopter money” that he believes is inevitable.

There are a few other well-known investors like this who seem to be perma bears and obviously someone who is always been bearish has been wrong more often than not….sort of. From the standpoint of making decisions based on what someone says in an interview, yes very wrong but that is the wrong way to look at it.

There is always a bear case and unless you are buy and hold on no matter what it makes sense to understand what the prevailing bear case and decide for yourself how much credence it deserves. The current state of the bond market is a great example. Yields have been at all-time lows and going lower for many years. Anyone who has bought has bought at all-time highs in terms of price. Buying high is of course risky but has continued to work. There are plenty of people who believe the yield on the ten year US treasury note can go to 1%. Buying at 1.60% is risky, to the Gross quote above, but if the yield does drop to 1% then anyone buying at 1.6% will do quite well on the trade.

Napier is concerned about a lot of things including a deflationary outcome. Were it to happen it would be very bad for a lot of assets and by extension it would be bad for a lot of investors’ portfolios. That deflation is a threat is certainly not a new idea and if you want to know what that could mean, you should read the linked interview, Napier spells it out very well. After reading the interview you might think he is wrong but in terms of understanding the issue, it is valuable read.

david@mediaworksllc.com

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.

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