Tyler Mordy, a financial advisor with Canada-based Hahn Investment Stewards, has been saying for a few years now that long-term yields will be pinned to super-low levels for a quite a while, as the developed world works its way out from under a mountain of debt.
But in an interview with IndexUniverse.com Managing Editor Olly Ludwig, Mordy stressed that his ETF-only firm isn’t rushing to put clients in Treasurys.
Instead, Hahn is looking at alternative sources of yield, such as sovereign debt from the emerging markets or REITs. He also said Hahn is gravitating toward investments that can buck the slow-growth trend, such as equities focused on biotech and gold miners.
Ludwig:You’ve been putting clients on the long end of the yield, to the extent that that makes sense in their particular asset allocation plans. There's a lot of worry about a bond bubble these days. Give me some nuance into your thinking.
Mordy: First of all, talking about bond bubbles is quite ludicrous—or, I should say, has been ludicrous over the past few years. No. 1 is that bubbles don’t form when an asset class is so despised. People who fail to see that don’t know the definition of a bubble.
Secondly, there has been this unhealthy obsession with the supply of bonds without an equal focus on the demand side of the bond side, which is just faulty analysis. And that’s the same analysis that went wrong in Japan for years. What we’ve seen there is that the decline in the Japanese government bond yields over the last 20 years—even though deficit spending has been spectacular—the debt-to-GDP ratio there is now over 200 percent.
But again, the focus is on the supply side, rather than the demand side; or, I should say that an equal focus on the demand side has been missing.
Ludwig:Let’s talk about that demand, because that’s part of the bond-bubble argument, that one fine day the U.S. Department of Treasury is going to have an auction, and nobody will show up. That’s the over-the-top, worst-case scenario. So what is it about the demand that makes it so persistent, so constant and so underestimated?
Mordy: The big thing is the demographic wave that’s happening right now. So it’s the baby boomer demographic which now has said, “Cash isn't king; cash flow is king.” It comes down to that. The demand side is overwhelming the supply side. Advisors can see this in their own practices.
Ludwig:So let me just parse that:People talk about the baby boomer generation—people who were born from 1946 to 1964. If we’re talking about a hockey game—since you're Canadian—what period are we in, in terms of this demand pull?
Mordy: Well, my view is that we’re in what we call a balance-sheet recession. That’s a fancy way of saying that there's too much debt in the world, mainly on the private-sector side, though it’s morphing more onto the sovereign side. If you look at what a balance-sheet recession is, it’s a shift from an era of financial liberalization to an era of financial prudence. So now what you see is saving-rates going through the roof, and just a general repair within the private sector of balance sheets.
So, when you look at what they would need to do to repair that—in other words, to reduce debt, to get income up and so forth—it just leads you to demand for all types of yield-oriented investments. Treasury bonds aren't special. This is holding true for REITs; this is holding true for preferred shares and all these other income-oriented asset classes.
Ludwig:So what are the signals that you guys are looking for, that might make you rethink this? After all, the bond-bubble crowd is probably saying, “Boy, those guys are reaching for yield, and they're asking for trouble.” You're saying, “Not so quick. But we would reconsider our view if such-and-such happens.” What is that scenario?
Mordy: Well, to be clear, we have had this epic bond rally. So the risk/return trade-off, obviously, is much, much less attractive right now. So we’re not saying go all in on Treasury bonds at this point, by any means. We’re actually going out of Treasury bonds into more yield-oriented investments. But the big thing—and this is the third counterpoint to the talk of this bond bubble—is that inflation is not really a well-understood phenomenon.
We’ve thought that the risk was more deflationary, or disinflationary, rather than inflationary. And there are a couple reasons for that. First, credit growth was actually declining, which is something new in the post-war period. In other words, bank lending was declining. Second, the velocity of money in circulation was also declining. Third, income growth was very muted, so inflation rarely occurs in that situation. And then finally, you’ve got this issue of lots of spare capacity.
So, if you look at those four factors, the most important one by far—in trying to determine the end of this so-called bond bubble—is credit growth. You could say that classical economics is sort of under siege right now. The economic textbooks are going to have to be rewritten, simply because they always assumed that when interest rates were lowered, you would get a commensurate rise in credit. And this is the first time in the post-war period that that hasn’t happened.
Mordy (cont'd.): But this balance-sheet recession, or secular bear market—whatever you want to call it—the post-financial-crisis period, to go back to the hockey analogy, I think it’s more in the third period than anything, and I will remind American readers that that’s the last period.
We’ve been successful in this bond call for a long time. And I still think that the declarations that the bond market is in a bubble still don’t align with the facts. But it’s pretty hard to recommend a 10-year Treasury note yielding 1.44 percent right now.
Ludwig:Fair enough. So, if it’s not U.S. T-bills or T-bonds, where are the attractive income options for your allocations using ETFs?
Mordy: We reject the notion that the static 60/40 asset allocation is the best way to go. We don’t hold ourselves hostages to that architecture. Our thinking is that most of the portfolio architecture, without being too caustic, is increasingly dissonant with economic and financial realities.
And the response is to take a more eclectic approach to your asset mix. And we use ETFs, which have been revolutionary in redefining the portfolio construction process.
So, when we look at this specifically, we run something called a “HIT” approach. That’s an acronym for “hitting back at the slow growth world.”
Ludwig:So what does HIT stand for?
Mordy: High quality for the “H.” So safe assets are in short supply. So, on that one, you could look at the emerging markets where credit quality is increasing, whereas in the developed world, credit quality is declining. Even if you take the G3, and you take U.S., Europe and Japan, and you look at their debt-to-GDP ratios, they're at about 110 percent right now. The emerging markets are collectively still below a 50 percent debt-to-GDP. And there's a whole host of other factors that point to better structural and physical factors on the emerging side, so that’s the redefinition of high quality.
Ludwig:The “I” stands for income?
Mordy: Yes, income. So that’s where the aging demographic faces an income crisis. And the slogan there is “Cash flow is king.” And, you know, you could look at something like an asset class, like the U.S. mortgage REIT ETF (MORT) from Market Vectors. It’s just sort of this niche asset class that gets the yield up really high. It’s also got low correlation to the broader markets.
Ludwig:What about these multi-asset-class income design-type securities we’re seeing on the market? What’s the one from Arrow that came out recently in the States (GYLD)? Would you use something like that?
Mordy: Our thinking has always been that we don’t outsource any active decisions because we’re a pure money manager, and we’re a global macro manager; we’re always looking for the purest building blocks. I'm sure they will do well, but it’s just not something that we use for our own portfolios.
Ludwig:So what about “T” in HIT?
Mordy: The “T” stands for thematics. So it’s any industry or sector that can untether from a slow-growth outlook. And for us, right now, you could look at a couple sectors:There's the biotech sector, which is doing extraordinarily well. There’s the gold mining sector, which hasn’t been doing well, but still is posting really high earnings. We don’t think the earnings are in jeopardy like the broader market, which are hitting stratospheric levels.
So it’s taking a nonbroad-based-index view of the world, and trying to look at the sectors and industries that can do well.
Ludwig:Does the “T” always imply equities?
Mordy: No, it could be anything. It could be bonds—it’s all the asset classes.
Ludwig:OK. And regarding this balance-sheet recession, do you have a template as to how long it may last?
Mordy: These balance-sheet recessions typically last about six to 10 years. And we’re basically in year four here. But it does happen unevenly throughout the world.
And if you look at who is deleveraging the fastest, it’s definitely America. And it’s happening a little faster than we would have thought.
Ludwig:So you buy into the notion that the U.S. could lead the developed world out of this slump?
Mordy: Very much so. We’re most encouraged by the U.S.’ progress. If you look at the debt reduction path in the U.S., debt in the financial sector relative to GDP has fallen back to levels seen in 2000, which is remarkable. That’s before the credit bubble—or at least the latter part of the credit bubble.
If you look at the household sector, it has reduced its debt relative to disposable income by 15 percentage points—more than any other country in the world right now that is on the path of deleveraging. So at that rate, U.S. households could actually reach so-called sustainable debt levels in less than two years.
De-leveraging is probably the most important piece of the recovery. But, of course, the second one would be that the U.S. dollar has already crashed. In other words, Mr. Bernanke has been very successful in depreciating the currency. And in a globalized world, he or she who has the lowest currency wins in export markets. And we’re seeing that right now, as U.S. labor is still among the cheapest in the world in many sectors. And exports are experiencing at least what we can call a mini-boom.
And finally, we’ve had a divine intervention in shale-gas technology. When Obama was elected in 2008, America imported about two-thirds of its oil. When you fast-forward to today, that’s now below half, and falling pretty rapidly.
So you’ve got those three things working in America’s favor right now. And, at least to us, that looks very, very encouraging.
Ludwig:And those three factors are again, de-leveraging; increase in exports based on a weaker currency; and a boom in energy.
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