August 2019 - Trade wars heat up; Summer of negative rates

This summer has heated up rather quickly, and not in a good way. Even before the horrific events of this past weekend, there was an air of tension and conflict in many areas around the world. Massive protests have been happening in Moscow, Hong Kong, Pakistan, San Juan, Paris and elsewhere. And the trade tensions between the U.S. and China have hit a boiling point that only appears to be getting worse. For a while now, it has been hard to see either side backing down and it is causing real damage to both of the largest 2 economies in the world.

None of this is good for economic activity, for business confidence or for the prospects for the remainder of the year. And the prospects are looking bleaker by the day.

This tension and conflict has led to a flight to quality in the bond market, causing bond traders to flock to the 10-year U.S. treasury in droves. This has caused even more pressure on the already-inverted yield curve and may have us at the brink of a recession. However, the U.S. economy chugs along and remains resilient. But how much more can she withstand?

In Germany, there has been such a flight to quality that government bond rates have turned negative. The benchmark 10-year German government bond is now at -0.60%. Just think about that – professional investors in Germany have such low confidence in equity investments, that they would rather park the money in government bonds, even though they have to pay the government 60 basis points to do so! That means that they are guaranteed to lose money! So their forecasting models must be telling them that prospective equity investments would yield even more negative returns than the negative bond yields, right? That’s a pretty rough outlook, wouldn’t you say? There is nothing to invest in that would potentially produce a positive return…in the entire country of Germany? Wow, that’s a pretty rough outlook for the German economy and for German companies. Keep in mind that this is not some trivial, small nation or economy. Germany is the 4th largest economy in the world and by far the largest and most important economy in the European Union and on continental Europe. Germany’s GDP is $4.0 trillion and makes up 28% of the output for the European Union’s overall economic production.

And yet, this is the reality that we find ourselves in August 2019. Globally, there is now over $15 trillion in debt that has negative yields. That is quite a statement. That is $15 trillion of capital that would invest in something, if it had the confidence to do so. But instead, it is paying to sit idle.

We will use this inflection point to make yet another plea to everyone to properly assess your leverage. Please exhaust all resources at your disposal to reduce your leverage on your personal and corporate balance sheet to appropriate levels. We’re not talking about high-growth companies or companies that are highly acquisitive. We’re referring more to mature companies, not in a high growth phase, that should be exercising as much prudence as possible to clean up their debt, right-size their balance sheet and make sure that they can comfortably cover all required principal and interest payments.

It looks we could be in for a bumpy ride for the remainder of 2019. As Warren Buffett would say, “it’s only when the tide goes out that you discover who has been swimming naked.” Well, we may be about to find out.