Consider Leverage In A Negative Yield World

April 17, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Wilfred Hahn, chairman and co-CIO of Toronto-based Hahn Investment Stewards.


What may have been considered a provocative view may increasingly move into broad acceptance—that being the necessity of leverage.


But first, consider that a rather unprecedented situation now applies—interest rates in many countries are at all-time lows. And as has been well reported, interest rates are negative on many sovereign bonds in Europe. The ECB’s aggressive new QE program has further driven down rates.


This new world of negative interest rates is indeed very strange. To wit, for the first time in history, the Swiss government issued new bonds recently at a negative interest rate. Imagine that! Governments can reduce their interest-rate bill by going deeper into debt.


Recently, an individual in Denmark was even able to borrow money from a bank at negative interest rates! Apparently, a bank may now want to pay you to take out a 96-month loan on a depreciating automobile.


For global investment managers, living in the netherworld of negative interest rates is discombobulating, to say the least. It flips upside down the entire question of asset valuation.


Negative rates will likely make currency in circulation boom in some (CIS, or Commonwealth of Independent States) countries. Why? Money stuffed in the mattress will actually outperform a bond investment.


But if central banks can expand their balance sheets with impunity, then unlimited demand for such CIS currencies will not be a problem. Actually, any kind of money will outperform a negative-yielding bond. But of course, policymakers will want to keep their monopoly on the production and incentivizations of money. So cash may in fact be banned at some point in the future.


Bubbles Everywhere

The key question for investors in this strange new netherworld of “anti-interest” is this: Just what other warps and side effects can still be expected to unfold?


There are many.


And that reminds us of the 1983 pop song by Nena—99 Luftballons. It was one of the very few German contributions to the North American pop scene. The Luftballon (English translation “balloon”) theme is definitely apropos to our discussion here.


Firstly, it is German. This is an influential nation again. Its actions are pivotal for Europe, and we expect a wave of European imports now that the U.S. dollar has soared versus the euro. However, it is the capital flow implications that are much more critical. The eurozone may soon be a huge exporter of money, too.


Secondly, balloons are close cousins to bubbles. The symbolism here is apt. Asset prices are increasingly being filled with “luft” (air) everywhere.


Of course, it is true that sovereign interest rates (nominal) are not negative everywhere, certainly not in the U.S. Nonetheless, rates are low and the contortions facing capital markets in Europe alone can have huge ramifications for the entire investment world. The incentives to engage in otherwise-perverse or risky tactics will be verging on the extreme.


Just what pension fund will be able to meet their future liabilities with such low rates? Just which European insurance company can safely lay off their risks in an environment of negative interest rates? How in the world will an aging populace retire with adequate financial income? Those are nigh-impossible questions to answer.


But perhaps the key one is, What can be done to mitigate the deflationary reality of low, low interest rates?


Find your next ETF

Reset All