By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.
The bond-fund massacre has been spectacular. Prime example: antsy investors yanked $7.7 billion in August out of the largest bond fund in the world, Pimco’s Total Return Fund. In July, they’d yanked out $7.5 billion, in June a record $14.5 billion. From May 1 through August 31, the fund’s assets shriveled 14%, from $292 billion to $251 billion; $26 billion from outflows and $15 billion from the shrinking value of the bonds. The fund lost 5.5% during that period.
By riding up the greatest bond bubble in the history of mankind, the fund has become known as a place where investors who don’t mind smaller returns but shudder at the thought of losing some of their principal could park their money without having to worry about it – but now, they’re worrying about it.
September is shaping up to be even worse. Bonds are cratering and yields are spiking worldwide. In the US, the 10-year Treasury yield kissed the magic 3.0% late Thursday, at least briefly, for the first time since July 2011, up from a low of 2.75% at the beginning of the month. It will drag other bond yields, mortgage rates, and other consumer and corporate rates behind it.
Pimco’s fund wasn’t alone: in total, $39.5 billion were yanked out of bond mutual funds in August, $21.1 billion in July, and a record of $69.1 billion in June. Emerging market funds, international bond funds… they’ve all gotten hit.
The Great Rotation out of bonds into stocks? Alas, that concept is vacillating between pipedream and deceptive hype, proffered by Wall Street for its own benefit. In reality, it doesn’t exist.
As bond-fund investors are pulling up their stakes, the hapless funds have to sell bonds, but for each bond they sell, there has to be a buyer, and for each dollar a fund receives for its bonds, there has to be a buyer willing to surrender it. It’s a zero-sum game. Um, plus the fees – because someone always makes money on Wall Street.
So the total number of bonds out there is constantly increasing as government and corporations issue new bonds and roll over maturing bonds, instead of paying them off with cash they’d put aside for that purpose (a concept that has become a quaint joke). This flood of new bonds must find buyers. Central banks have stepped in, with the Fed currently buying $85 billion a month, the Bank of Japan buying a lot, along with other central banks. In the end, there must be a buyer for every bond.
So there cannot be a rotation out of bonds. But there can be a rotation out of bond funds and into bonds pure and simple – and that is happening. It’s a painful process. As bond funds are forced to unwind their holdings, others step in to buy these bonds, at an ever lower price. This causes further bleeding in bond funds, more antsy investors who are yanking out their money, more force selling by bond funds….
It’s the unwinding of the “Wealth Effect” that the Greenspan Fed had pulled out of thin mountain air and incorporated into its unfounded belief system, and that the Bernanke Fed in its desperation elevated to a state religion, and a justification for printing $3 trillion, and that the Bank of Japan is now bandying about as part of its new religion.
They claim that inflating the values of bonds, stocks, real estate, farmland, MBS, no matter what kind of asset, by hook or crook, including forcing down interest rates to near zero and printing truckloads of money, will create “wealth” out of nothing, and that people who are thus “wealthy” will spend some of that “wealth” and crank up the real economy.
That religion hasn’t worked very well in the US – where the Fed is blowing $3 trillion on it. If it works at all, it only works for a limited time. Some individual investors, the lucky ones, can pull out their money and consume their gains, but investors as a whole cannot; because for each investor wanting to dump some assets, there has to be another willing to buy them. But they feel wealthier as they see their balance sheets or 401(k)s swell up. And so they might dip into their cash accounts or borrow against their inflated assets to buy some baubles.
Then the hangover sets in. Asset values cannot be inflated forever. Something has to give. Now bonds are sliding, taking down bond funds with them, and our antsy investors are dumping their shares, and bond funds are forced to sell more bonds just when other investors are reluctant to jump into the fray to buy them, and just when the Fed is contemplating pulling up its stakes too, and prices slide further. The giddy “wealth effect” that the Fed printed into existence evaporates, and people end up poorer, not only by the money that they thought they had and that they then spent, but also by the amount that their investments declined in value. It’s not an uplifting process. This is the wealth effect in reverse – the essential consequence of any wealth effect – and the Fed has wisely shrouded itself in silence on the topic.
“Bernanke’s maniacal money printing after the Lehman event catalyzed a virtual stampede back into the very same risk-asset classes which had been reduced to smoldering ruins,” David Stockman writes. It produced the craziest junk-bond binge of all times, allowing the mega-buyouts from before the crisis to survive and pay rich fees to the LBO lords.