Debt Is A Relative Value Asset Class
Debt Is A Relative Value Asset Class
The value is calculated by looking at what the cashflows and return of principle will be worth in future.
A 5% coupon will sound attractive or unattractive depending on what we think the value of money will be in future.
If I believe that long-term inflation will fall to significantly less than 5%, then the bond will have value and the price will rise.
If long-term inflation expectations are higher or expected to rise over time, my bond will fall in value.
For decades, expectations for future inflation went down. That was a secular tail wind for bond valuations.
As happens in every bull market, the supply of the asset class increased as the reliability of returns improved over time.
Importantly, the use to which all that borrowed money was put focused on increasing benefits rather than capital stock for the economy.
Social benefits increased steadily over the last forty years. That spending falls into two broad categories.
The first is services increased. The range of what governments are willing to pay for expanded significantly.
The second is pensions. Public sector workers have gold plated pensions. Not only that but the age at which they can retire has been falling.
Both these sources of spending have been supplemented by the boom in debt issuance. This is true for several large economies around the world.
It is not possible to make a broad statement about what companies have done with the debt they have issued.
However, the financialization of the economy, offshoring, the surge in buybacks and dividend increases, as well as the existence of zombie companies suggests the corporate sector has also focused on current spending rather than capital investment.
During the pandemic the supply of bonds accelerated and debt ratios became problematic.
Today several countries are dealing with significantly higher borrowing costs and rising expectations of future inflation. That is not good for bond values but also inhibits the ability to increase debt issuance.
Every time it looks like governments are insensitive to this issue yields rally further. Today we started to see some evidence that they are acting to reduce issuance.
