Bill Gross’s knocks the halo off of sovereign bonds in his latest March outlook.
He highlights how sovereign debt has been struck with more bad news than corporate debt lately.
While sovereign credit used to be generally considered more secure than that of private companies, suddenly the default of nations such as Greece, the U.K., or even Japan seems on the table, while that of many strong corporates remains remote.
What’s happening, according to Mr. Gross, is that government bonds are starting to look just like corporate bonds, rather than existing on some privileged less-risky peer as in the past. Because it’s anything goes and anyone can default in the new ‘unibond’ market:
Government bailouts and guarantees such as those evidenced and envisioned in Dubai and Greece, as well as those for the last 18 months with banks and large industrial corporations across the globe, suggest a more homogeneous “unicredit” type of bond market. If core sovereigns such as the U.S., Germany, U.K., and Japan “absorb” more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee. The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle.
This metaphor doesn’t really answer the critical question of whether a debt crisis can be cured by issuing more debt. The answer remains: It depends – on initial debt levels and whether or not private economies can be reinvigorated. But it does suggest the likely direction of sovereign yields IF global policymakers are successful with their rescue efforts: Sovereign yields will narrow in spreads compared to other high-quality alternatives. In other words, sovereign yields will become more credit like. When sovereign issues become more credit-like, as evidenced in Greece, Spain, Portugal, and a host of others, they move closer in yield to the corporate and Agency debt that supposedly rank lower in the hierarchy. That process of course can be accomplished in two ways: high-quality non-sovereigns move down to lower levels or governments move up.
Thus there are no longer any holy bond cows left in this world.
Heck, even U.S. bonds are subject to ‘stealth-default’ risk, which is simply the eating away of bond value over time via inflation and dollar depreciation. The investment implication, according to Mr. Gross, is that spreads (the difference between yields, with sovereigns generally having lower yields than corporates) will narrow between sovereign and corporate credits. He recommends looking at fundamentally stronger sovereign bonds such as those of Canada or Germany.
This, to us, also basically means that one should be short weaker sovereign debt while long corporate bonds with comparable or less perceived risk than many sovereigns, and that currently yield more than their fundamentally weaker sovereign peers of course.
As austerity protests in Greece show, a corporation can actually be far more disciplined in its treatment of spending than a country. Bondholders also have far more leverage over a company due to the legal process. If a U.S. company goes bankrupt, bondholders can step in and claim company assets. But if a sovereign nation decides to default, or even more likely, stealth-default, then there is nothing bondholders can really do in the end. Thus in a unibond world, trust in strong companies over even average countries.
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