magine investing in something knowing you’re almost guaranteed to lose money over time. It’s hard to fathom why you would put yourself through the emotional stress of dealing with such an investment in your portfolio. Yet in some areas of finance, what many deem to be crazy investments are becoming both normal and attractive.
Financial institutions across the world have engaged in an accidental war, battling it out to create the most extreme monetary instrument available. And the reason behind it all? To achieve the highest yield possible. With inflation continuing to drag on asset classes with a lower principle than the real rate — interest minus inflation — the race is on to stock up and profit from risky high-yielding assets.
If you thought negative-yielding government debt was tempting enough then you’ll love the current frontrunner in the global reach for yield: public European corporations who issue negative-yielding CJBs (Corporate Junk Bonds). Products created by financial institutions that allow you, the buyer, to pay to lend money to the issuer, but without the guarantee of state support to back you up when things go wrong.
As Bloomberg reports, the number of European public companies offering negative-yielding junk bonds has increased from 0 to 14 over the last year. But the quality of the companies behind these bonds will surprise even the most active market observer. They’re not risky small-cap companies with a long list of liabilities to their name, instead, they are global large-cap corporations: Axalta, a global chemical coatings company, Altice, a multinational telecom company, and Nokia — a name that needs no introduction — demonstrating just how crazy the economic situation is in mainland Europe. How industry-leading companies have to entice investors into paying for a potential gain in bond prices rather than the yield itself, and that’s without considering the junk credit ratings, meaning investors will dump these assets at the first sign of economic trouble.
So why are investors considering these bonds? Why take the loss? Why pay to lose? Why is there even a market in the first place? Well, despite all the negatives, one positive surpasses them all: According to the economist, Daniel Lacalle, a market exists for these assets because they offer a long-term bet. A bet that governments will bail out companies at whatever cost if they deem them too big to fail. So as an investor, you’re no longer studying, analyzing, or considering economic fundamentals, it’s whether you believe the government will keep a company alive long enough for you to make money.
This plays into the “buy the dip” phenomenon that’s becoming popular in modern finance where you are rewarded for being “risk-on” even when economic fundamentals are against you. History tells us this is a sound short-term investment strategy, but only if you invest in the appropriate industries. Looking back at the US automotive sector during the financial crisis of 2008, all major car companies — General Motors and Chrysler in particular — were on the brink of bankruptcy only to be rescued by the federal government, and ever since these stocks have made investors who took the gamble triple-digit percentage returns.
Another buyer — although it’s hard to believe — is the European consumer. If you’re concerned about what’s happened over the last decade, taking into account a highly overvalued stock market, an unstable banking system, and an unsustainable government-debt level, a once crazy-sounding junk bond investment becomes rational. It shows many European citizens lack the confidence to place their money in both government assets and institutions and will gladly take on corporate risk despite the guaranteed loss over time — to some, a small loss is better than unrealized gains.
This speculative trend will define the next decade as a loose monetary policy stance from the ECB (European Central Bank) will continue to support riskier investments that would cease to exist without stimulus. The ECB is willing to keep injecting liquidity into the financial system as long they can maintain stability in the economy hence risk assets will remain in popular demand for years, maybe decades to come.
The only thing stopping the reach for yield narrative is the central bank confidence bubble bursting, but as the last economic cycle proves, the market believes in the power of money printing to rescue the economy. Any sign of stress within the financial system is met with a fast response from the authorities; a response that the market continues to have total faith in as society begins to accept the new norm of a central bank, liquidity-driven economy.
