Wall Street Veteran: The Bond Sell-Off Is A Buying Opportunity

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Ed Elson (2:07)

Welcome to Prof G Markets. I'm Ed Elson. It is September 29th. Let's check in on yesterday's market vitals.

The major indices declined as the US and Iran appeared deadlocked in negotiations. Brent crude climbed as high as $108 per barrel before settling around 105

The yield on 10-year treasuries hit another 52-week high. More on that later. And finally, the odds of a rate hike in October climbed to 70% on Cauchy.

Okay, what else is happening? The bond sell-off is deepening. After President Trump rejected Iran's proposal to reopen the Strait of Hormuz over the weekend, Brent crude soared to $108 per barrel. US bonds sold off, and the 10-year yield climbed towards a 24-year high. Meanwhile, the 30-year yields are now near their highest levels since 2004 European bonds also sold off, with French borrowing costs at their highest levels since 2008 Stocks fell across the world, as investors grapple with what persistently high yields would mean for the equity markets. Joining us to discuss this, we are speaking with Michael Green, CEO and CIO of Tier1 Alpha Asset Management. Michael, good to see you again. Welcome back to Prof G Markets. Let's start with yields here. The 10-year coming up close to 5.3. It's above 5.2 percent. 30-year yield above 5.5 percent. I mean, this keeps on happening. This sell-off doesn't seem to end. What do you make of what the markets are telling us, what the bond markets are telling us, and what does it mean for stocks?

Michael Green (3:47)

Well, unfortunately, I think what it is telling us is that the mechanical properties, as you've heard me emphasize in prior discussions around passive investing, are now playing out in the bond markets. This is particularly problematic because the bond indices that passive vehicles reference was never designed as an investable product. It was not designed to represent a specific risk, which would be appropriate for investment. Instead, it was designed to represent pure representation. What is the total quantity of bonds outstanding?

That means, unfortunately, that there's very little thought that's actually going into this bond sell-off. There's lots of narratives that exist around it, that the United States is running unsustainable deficits, or that France is running unsustainable deficits, or that debt to GDP is higher than it has been, and that somehow or another explains the sell-off that we're seeing. Unfortunately, that isn't borne out by the facts. If we look at a country like Australia, which has a low debt to GDP, it's experiencing the same sell-off. You look at countries like Switzerland, which are also running deficits, they're experiencing very different behavior in their bonds, as is China, which is now part of Western bond index markets.

What we are really seeing, unfortunately, is the mechanical byproduct of an investment strategy that says a bond that is trading below par is significantly less attractive in terms of incremental capital allocation as a bond trading above par, even if they're from the exact same issuer. So there's no difference in credit risk or anything else. It's simply a function of how we've decided to build the indices that is creating most of the behavior that we are seeing at this point. It's analogous to the nonsense that occurred around the.com cycle when a similarly improperly constructed equity index brought to light the distortive impacts of passive investing at much lower levels of passive penetration than we are seeing now in the equity markets, where my work is well known. In the bond markets, this is not thought, this is not investment opportunity, this is a mechanical feature of how we've structured the markets, and ultimately we will have to address it.