There are at least two other storm clouds massing on the horizon (we ignore the worsening geopolitical outlook altogether). One is the ‘health’ of the bond markets. Bloomberg’s Mark Gilbert points out that Germany has just issued €4 billion of two year notes that pay no interest whatsoever until they mature in 2016. The second is the explicitly declining health of the euro zone economy, which is threatening to slide into recession (again), and to which zero interest rates in Germany broadly allude. The reality, which is not a hallucination, is that years of Zero Interest Rate Policy everywhere and trillions of dollars, pounds, euros and yen pumped into a moribund banking system have created a ‘Potemkin village’ market offering the illusion of stability.

Regardless of the context, stock markets at or near all-time highs are things to be sceptical of, rather than to be embraced with both hands. Value investors prefer to buy at the low than at the high. The same holds for bonds, especially when they offer the certainty of a loss in real terms if held to maturity. But as Elliott point out, the job of asset managers is to manage money, and not to “hold up our arms and order the tide to roll back”. (We have written previously about those who seem to believe they can control the tides.) So by a process of logic, selectivity and elimination, we believe the only things remotely worth buying today are high quality stocks trading at levels well below their intrinsic value.

David Fuller's view

Here is Tim Price's Letter.

To feel comfortable with today’s 10-year government bond yields in not only Japan but also Europe, the USA and several other Western countries, one has to be very confident that these regions will remain in a deflationary environment for a number of years. 

Japan has certainly been in a deflationary rut for much of the last two decades but Shinzo Abe’s government and the central bank are increasing efforts to change this as part of their effort to increase GDP growth.  It takes time but I think they are in the process of succeeding.  JGB yields shown above are becoming overextended once again.

Europe faces a deflationary challenge, unless the ECBs Mario Draghi is given the freedom to commence quantitative easing (QE).  Continued recession and deflation would be devastating for European countries which are already saddled with unacceptably high unemployment.  It could break up the euro zone, for better or for worse.  These risks are increased by Putin’s dangerous political and military manoeuvres.  Nevertheless, German Bund yields shown above are clearly overextended.

The USA is in a much stronger position, despite uncompetitive corporate taxes which impede GDP growth and employment, and a White House that is more interested in wealth redistribution than generation.  Nevertheless, nothing more than temporary pockets of deflation in a gradually recovering US economy seems likely, short of an exogenous disaster.

Long-term investors in US 10-Yr Treasuries and other developed country bonds could be forgiven for feeling smug.  They have made excellent returns for many years while routing short sellers in the process.  Those of us who have talked about a bubble about to burst have been premature.  Moreover, bond investors can justifiably claim that they are aligned with the Fed, not fighting it.  Nevertheless, they risk suffering the fate of those well-fed plump rabbits in Richard Adams’ novel, Watership Down.  I hope they have protective stops. 

I agree with Tim Price’s investment preferences mentioned in the second paragraph above.  However, in a persistent bull market led by NASDAQ-listed tech shares, holding so-called “high quality stocks trading at levels well below their intrinsic value,” can feel discouraging while they continue to underperform. 

BHP Billiton (est p/e 12.56, yield 4.23%) and Rio Tinto (est p/e 10.17, yield 4.24% are two examples which some of us have in our portfolios.  The immediate problem which has weighed on these shares in recent weeks is a further decline in the price of iron ore, reported by The Telegraph: Miners face $30bn revenue hit from falling iron ore price.  This may not recover before China’s economy strengthens but the yields are probably safe.  I may invest some of the accumulating dividend revenue in my personal account in these two shares.