“The world has much to fear,” James Grant declares in a recent issue of Grant’s Interest Rate Observer, “However, it seems to us, not the least of these perils are the alleged safe havens themselves.” Therefore, says Grant, “In general, this publication is bullish on things certified to be unsafe, bearish on things certified to be safe (assuming always that the respective prices are right).”
Specifically, Grant is bearish on one of the very “safest” of safe things: highly rated government bonds. “The times may be troubled (they often are),” he says, “and people may be desperate (someone usually is), but that doesn’t mean that low-yielding sovereign debt is the last word in safety and soundness.”
Grant does not assert that top-tier government bonds are necessarily unsafe, merely that they are undesirable…and potentially unsafe. At current yields, many government bonds offer what Grant has termed, “return-free risk.”
As the nearby chart clearly shows, the yields provided by the marquee AAA government bonds of the US, Germany, Switzerland and the UK have been in a freefall for several years. As recently as four years ago, a 5-year bond from the Swiss government yielded about 3%. Today, the 5-year yield is negative! That’s right; an investor must pay the Swiss government for the privilege of lending it money.
The 5-year yields provided by the other AAA issuers in this chart are at least positive, but just barely. All of them yield less than one percent per year. Longer-term yields from these AAA-rated governments are similarly underwhelming.
Therefore, Grant suggests, rather than buying the 10-year German bund that yields a whopping 1.75%, why not buy the common stock of the German chemical giant, BASF, which is currently yielding about 4.3%?
“By the same token,” Grant continues, “we favor Wal-Mart over the 10-year Treasury, and Nestlé over the 10-year Swiss government note. Wal-Mart, which yields 2.4%, and Nestlé, which fetches 3.5%, have shown the ability to grow and adapt in economies both good and indifferent.”
Clearly, the shares out of BASF, Wal-Mart and Nestlé are not “safe” in the sense of providing a certain, government-guaranteed return. They are safe only in the sense of offering a potential return over time that greatly exceeds that of today’s ultra-low yielding sovereign bonds.
Furthermore, equities deliver returns that derive from real-world commerce, rather than from the increasingly dubious promise of a heavily indebted national treasury.
But equities are not the only compelling alternative to government bonds, according to Grant. He argues that the “risky” housing market is on the verge of providing very compelling investment opportunities — both for current income and for capital gain. “In so far as houses have been a ball and chain on the leg of the American economy,” Grant remarks, “that leg is — so we believe — in the process of shedding its shackles.”
Regular readers of this column may recall that our own Chris Mayer, editor of Capital and Crisis, has also become a big fan of US housing-based investments. (In fact, Chris identified one particular housing-focused partnership that Jim Grant subsequently examined in the pages of Grant’s Interest Rate Observer. Out of respect for the subscribers of both Grant’s Interest Rate Observer and Capital & Crisis, we will not divulge the specific real estate investments that either publication has highlighted for its subscribers).
“Being bullish on housing is a contrarian view,” says Chris. “In a recent national survey, 37% of homeowners say they think buying a house is a ‘risky investment.’ And 86% think prices will either stay flat or fall.
But Chris believes the housing doom-and-gloomers have got it wrong. He thinks the housing market is on the verge of a rebound. “Real estate is intensely local, of course,” says Chris. “It is hard to generalize. But clearly, there is value out there.
“One individual I know runs a partnership that has purchased 87 homes in Georgia and North Carolina during the last year. When he leases out these homes, his firm averages a 16.5% gross yield. That’s annual rent divided by purchase price, plus closing costs and estimated repair costs. And that is without leverage, net of all expenses, and includes estimates for vacancy and maintenance.
“This is what the big-picture guys miss,” Chris continues. “Economists can talk all they want about how a housing recovery is years away. Maybe so, but the opportunity to invest and make good money is now. In a world of sub-2% Treasury rates, 16.5% gross ain’t bad.
“Now, I am not saying a housing boom is about to happen,” Chris concludes. “There is more wood to chop before we get there. But I am saying that American housing, as an investment asset, looks cheap.”
“Bye-bye, then, to the McMansion phase of the American home investment cycle,” echoes Grant, “Hello to the era of McBargain.”
Eric Fryfor The Daily Reckoning
Eric J. Fry, Agora Financial's Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling.
Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.
“rather than buying the 10-year German bund that yields a whopping 1.75%, why not buy the common stock of the German chemical giant, BASF, which is currently yielding about 4.3%?”
because it’s hard to park $20 billion in an unstable stock, while parking $20 billion in a stable sovereign bond is much easier.
cute. but risk is relative. the question is “where can I park $20 billion so that it is least likely to disappear?” in light of THAT question and in light of present conditions a slight negative return is well worth parking money in a “safe” location such as u.s. swiss or german bonds.
who does this guy write for?
you think those bonds are going to have a real rate of return of 0% over 10 yrs or more? Anything that’s value is denominated in sovereign fiat is at grave risk in my opinion, unless it’s something you can get out of very very quickly, 24-7, 365 days a year and can’t be inaccessible due to emergency measures invoked by the government.
“If you don’t hold it, you don’t own it.” This is the mantra in times such as these. And I don’t mean holding paper that is a claim on goods. I mean holding the goods themselves. And an additional level of safety would be having the ability to easily hide or move wealth, and gold would fit this definition very nicely.
Of course hoarding your wealth in gold and not investing in wealth producing entities is not a good long-term strategy for richer world, but when things are as volatile as they are today, it’s a good wealth-preserving strategy to employ if you wish to have any wealth to put to work after the state of all this dilution of money substitutes’ value is more fundamentally resolved.
I love Jim Grant, but he was bullish on gold 20 years too early and pulled out of Japan and closed his stock fund calling a bottom there, someday US housing will recover, but first you need a catalyst, perhaps the US Government getting out of the mortgage business might help- do you see that happening anytime soon?
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