As I mentioned in a recent article, the dominant characteristic of the post-2008 era has been widespread monetary intervention by central banks and ultra-low interest rates. Over the last decade, this has led to the creation of what distressed credit investor Howard Marks (Trades, Portfolio) calls a “low-return, high-risk world.”
Nothing has changed
In previous decades, investors and savers were able to live off of the interest paid by government bonds or savings accounts. The worldwide slashing of interest rates that has occurred over the last decade has made it impossible for these conservative savers to live off of that income. Accordingly, they have had to "reach for yield" - that is, take on more risk than they otherwise would have liked - in order to earn the same amount of return that they used to.
As Marks stated in a talk at the CFA Society of Chicago, this has contributed to a number of trends, namely:
“The longest bull market in history, the ascendent superstocks - the FAANGs - strong demand for corporate credit, money flows into emerging market debt, record fundraising for private equity, the onrush of capital for tech and VC investing and interest in cryptocurrencies.”
It should be noted that Marks gave this talk prior to the March 2020 market collapse. However, what has really changed from the market perspective since then? The benchmark S&P 500 index has largely recovered, demand for tech stocks is higher than ever, interest rates are still at all-time lows and the Federal Reserve has essentially guaranteed to support demand for corporate credit. In my opinion, nothing has fundamentally changed about the “low-return, high risk world,” except perhaps the understanding by (some) investors of what that risk might look like.
I certainly don’t think that investor psychology has been reset in the way that protracted bear markets have done in the past. If anything, the reach for yield is greater than ever - stock prices are back to around their pre-lockdown levels, even though corporate earnings are expected to significantly undershoot their 2019 comparisons.
Learn from history
Incidentally, this is not the first time that a low interest rate environment has led to a reach for yield. In the 1820s (yes, you read that right), interest rates on UK government bonds (consols) dropped significantly, and staid investors who used to be happy to live off of the coupons paid by those bonds were forced to take on more risk than they otherwise would have liked to.
In 1825, investors were so willing to suspend disbelief that a Scottish con man named Gregor MacGregor was able to sell over a billion dollars worth of bonds of a completely fictional Latin American country he called "Poyais." I would highly recommend reading the whole story, as it is a fascinating look into investor psychology as well as an entertaining tale in and of itself. This era was characterised by speculative manias and a flood of cheap credit.
Sound familiar? It seems like the more things change, the more they stay the same.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Why Do Bubbles Occur During Recessions?
- Howard Marks: The Market Cannot Tell You the Future
- Jim Chanos: The Problem With the Gig Economy Business Model
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