Global Equities Research: Downhill Skiing In Holland

Federal Reserve - Global Equities research


The mighty Vaalsberg towers above the surrounding countryside, a hidden gem of a challenge for the world’s most dauntless mountaineers. At 322 metres above sea level it holds the crown of Holland’s tallest hill. Now small hills standing in for mountains are to be expected when a quarter of your country stands below sea-level and a further half manages to stretch a single metre above the level of the waves beyond the dykes. As a result, centuries of experience   have burnished a world-beating Dutch reputation for drainage, swamp clearance and reclaiming land from the sea.

Rather than centuries of experience of managing the flat-lands, only a juvenile decade has passed since the Great Financial Crisis felled interest rates, $13tn and counting of bonds trading at sub-zero rates now standing in for economic life below sea-level. However, unlike the Dutch, there is little evidence that swamp drainage is a virtue which the captains of the world’s central banks can lay claim to. 

Yes, low rates soothe the nerves of governments and private companies over-burdened with debt. Yes, it props up the value of all types of assets. However, low interest rates have also given birth, air and sustenance to a fierce looking triplet: the first of these comes in the number of “Zombies” – the colourful term which the financial media has given to companies unable to cover debt servicing costs from current profits over an extended period – currently at a record according to the Bank for International Settlements’ quarterly review Q3 2018. 

The next comes in the shape of “Cov-lite loans” – loans with limited to no protective covenants for lenders, which are also at all-time highs. These are linked to “leveraged loans”, or loans granted to companies with exceptionally high levels of debt to underlying profits. Such loans, according to the Federal Reserve Financial Stability Report, have consistently grown and have now reached a volume of $2.2tn, half of which are in the US. Incidentally, this US portion is almost exactly the same size that the US sub-prime market peaked in 2007.

The final sibling comes in the proportion of bonds with a BBB minus rating, the lowest investment grade prior to “junk”. As seen on this IMF graph, these have increased in Europe from 14% in 2000 to at least 45% as of the end of Q2 2019.

Companies kept alive due to the goodwill of central banks, projects funded which previously would never have seen the light of day, the quality of bonds steadily worsening: none of this is good news for returns. Central bank monetary easing means that capital and above all recklessly deployed capital has no incentive to leave the market. This makes it tougher for everyone. It’s heavy-going wading through marshlands. Each passing year makes it tougher for corporates as a whole to make an adequate return. You can see this in steadily dropping rates of return in western markets, which are inching down towards Japanese levels. When it comes to managing the fallout from a debt bust, they have a head start.


So what can central banks do if the monetary medicine becomes less and less potent? Yet greater innovation seems highly likely. The shape that will take is still uncertain. Some advocate so called “helicopter money” where money created by central banks is put directly into consumers bank accounts, others talk of “debt monetisation” where debt is simply cancelled by the central bank, others such as Mervyn King, the well-known economist and former Governor of the Bank of England, suggest central banks become “pawnbrokers” for all seasons, with an even greater role in managing retail banks than they do now.

What is certain is that “more of the same” brings ever smaller thrills. For the best way to kick start a traditional monetary easing boost is for interest rates to pick up momentum by skiing down from on high. But in this interest rate cycle, US rates have climbed up the equivalent of Holland’s tallest hill. You can’t build up much speed skiing down the Vaalsberg.


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CLI01477 Expiry 30/09/2019

Daniel White

Daniel White

Senior Research and Strategy Manager

LF Canlife Global Equity Fund

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