Don't Mistake Credit Rally for Confidence
Investors are whipping themselves into a panic over slowing growth, political instability and even the health of the European banking system. Classic haven investments, namely developed-market government debt, are posting historic rallies, with yields falling to record lows.
Yet investors are also racing to lend to companies. They've poured $2.9 billion into U.S. investment-grade and high-yield corporate bond exchange-traded funds in the past week, according to data compiled by Bloomberg. Even yields on company bonds in the U.K. have fallen to record lows despite predictions of gloom and doom for the nation's economy after its vote to exit the European Union.
A growing number of companies, such as Procter & Gamble, Apple and General Electric, can now borrow for free in Japan and Europe.
On one hand, this makes absolutely no sense at all. The frantic race into government debt suggests a coming downturn, which would challenge the solvency of some companies. And yet the rally in corporate debt implies a more sanguine feeling about the state of the global economy.
The latest credit rally, however, is not a sign of optimism. It's a sign of resignation. Investors increasingly believe central banks will keep rates low for a long time and even purchase more bonds, including those of corporations, to keep markets from falling apart.
Rather than simply pile into sovereign debt, traders are increasingly treating company notes as proxies to government liabilities. Who could blame them? They otherwise stand to earn nothing on a swelling volume of bonds, with more than $12 trillion of negative-yielding debt globally.
Of course, there's a huge risk: Companies are not the same as governments. They should be allowed to fail without causing market-sized earthquakes. And some of them will fail as technologies and trends change. Investors are largely disregarding that risk at the moment, in large part because central bankers are sending a message that they'll backstop anything and everything if need be.
For years, investors have thought that central bank intervention was unsustainable. Perhaps it will be eventually. Central bankers appear to be running out of ammunition and are increasingly pleading for some help from policy makers. Lawmakers, on the other hand, are competing in personal popularity contests and having fits of ennui about the meaning of government -- hardly a backdrop for some meaningful, helpful policies.
In the meantime, investors will continue to rush into the corporate-debt markets because they have few other places to go. Lack of options shouldn't be misinterpreted as confidence.
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