Reach-for-Yield Buffet

I was recently invited to listen to a sales pitch for investments that generate income outside of the public markets.  While normally avoiding this sort of thing like the Plague, curiosity got the better of me.  The event was well attended, the short rib cooked to perfection and the sponsors put on quite a show.

“Stocks are too high and yields too low.”  “The economic expansion is long in the tooth.”  How does one generate income in such an environment without taking undue risk?  Answer: find lucrative niches where banks are restricted and large institutions can’t be bothered.  The menu included short-term lending to small businesses, rehabbing Class B commercial real estate, and funding lawyers to file personal injury claims.  At a time when over 80% of the world’s bonds yield less than 3%, these financial alchemists are allegedly generating steady returns for their clients of 10% or more, while making a nice living for themselves.

The leader of this smorgasbord was convincing.  He knew his material and which buttons to push.  People were desperate for a solution and he was there to help.  His pitch came across as unscripted, but was obviously well rehearsed.  He encouraged crowd participation and asked to see a show of hands.  “How many of you are current clients?”  A majority of the room raised their hands.  “How many feel we’ve done everything we promised?”  Every hand stayed in the air.  He introduced his team which included several attractive young women; one was dressed more appropriately for a nightclub than a buttoned-up business meeting.  There was a sense of community, a feeling of wanting to be with the “in crowd.”  Fittingly, a camera crew filmed the entire spectacle. The Untold History of ... Oliver Stone, Peter Ku... Best Price: $11.64 Buy New $10.99 (as of 10:35 UTC - Details)

Initially skeptical, I found myself drawn in, wanting to believe.  Upon reflection (and a good night’s sleep), I realized this movie has played out many times before and rarely ends well.

Religious cults, political movements and financial manias all follow a similar script.  A group of people are vulnerable and desperate.  They could be troubled teenagers, victims of inflation, the unemployed, or baby boomers who haven’t saved enough for retirement.  Along comes a smooth talker with an outsized personality who offers a “too good to be true” solution.  He is persuasive in part because he truly believes in what he is selling.  The message must be simple, not just to be grasped, but so that it will spread like wildfire, repeated endlessly until others accept it as gospel.  There is the powerful sway of the group, strength in numbers.  What everyone is doing must be right.  Straying from the group and questioning the wisdom of the crowd is heretical while conformity is demanded.  Finally, there are the inner contradictions of the reigning belief system which ultimately lead to its downfall.

Nazi Germany is a classic example.  Ravaged by the Napoleonic wars and World War I, and the social fabric frayed by Bismarck’s welfare state, Germans were vulnerable to a charismatic leader promising to restore national pride.  Into this void stepped Adolph Hitler with visions of making Germany great again.  The Nazis were master marketers.  Hitler would practice his speeches in front of a mirror.  The Nazis pioneered the use of propaganda films directed by the innovative Leni Riefenstahl in the 1930s.  According to Wikipedia,

Triumph of the Will was released in 1935 and became a major example of film used as propaganda.  Riefenstahl’s techniques – such as moving cameras, aerial photography, the use of long focus lenses to create a distorted perspective, and the revolutionary approach to the use of music and cinematography – have earned Triumph of the Will recognition as one of the greatest propaganda films in history.  Riefenstahl helped to stage the scenes, directing and rehearsing some of them at least fifty times.  Riefenstahl won several awards, not only in Germany but also in the United States, France, Sweden and other countries.

The American presidency has become increasingly Hollywood-ized.  After Ronald Reagan gave a speech in China in 1984, he was asked what he learned in college that helped him as president.  “Well,” he replied, “of course I was an economics major, but you’d be surprised at how helpful my classes in acting have been.”

Donald Trump, media personality, reality TV icon and marketing genius, is the latest pitchman tailor-made for the times.  Many middle class Americans, hurt by the mid-2000s housing bubble, were left behind by eight years of asset inflation under the Obama administration.  “Protection will lead to great prosperity and strength,” Trump promised in his inaugural address.  Pressure on the Fed to lower interest rates is also meant to restore the pre-everything bubble prosperity.  Obama’s “big, fat, ugly bubble” on the campaign trail has quickly transformed itself into “the greatest economy in the HISTORY of America” under Trump stewardship.

Today, many investors who are starved for yield are taking on added risk to compensate, bringing to mind the adage, “more money is lost reaching for yield than at the point of a gun.”  At times like this, it pays to distance oneself from the crowd and question its underlying logic.  Are the world’s central bankers capable of preventing a severe recession or bear market?  Are government bonds yielding less than nothing “safe?”  Are buying such bonds and front running the world’s central bankers a license to print money or picking up nickels in front of a steamroller?

The greatest monetary experiment in history long ago went beyond the point of absurdity.  Nearly $14 trillion in bonds around the globe have negative yields, a record.  The governments of Denmark and Switzerland are essentially being paid to borrow money.  Apple, AT&T and McDonalds can borrow in euros at less than zero.  How and precisely when this will end is anyone’s guess, but as an investor, you don’t want to be anywhere near when it does.

Whenever something sounds too good to be true, it probably is.