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Get Think Tanked Distilled with Steve Van Metre

Posted by Michael Venuto on Sep 21, 2021 10:30:00 AM
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Steve Van Metre is known as the "bond king" but he’s also a macro fund manager, YouTuber and the inventor of Portfolio Shield, a unique investment strategy designed to take risk when the equity markets are rising and reduce risk when the equity markets are falling. Recently, he joined the ETF Think Tank to talk about the Fed’s impact on the financial markets, where the bond market could be headed next and his thoughts about what’s going on in China.

Van Metre says that one of the biggest symptoms of trouble in China is Evergrande, the country’s 2nd largest property developer and largest junk bond issuer, announcing that it will default on its debt payments due to a sudden cash flow problem. Some market watchers are describing it as China’s Lehman Brothers moment and could be the biggest test to the country’s fragile financial system. Van Metre notes that it doesn’t look like the government is going to step in and bail them out, so risks of investing here are high.

One thing he’s not worried about is China’s willingness to buy U.S. Treasuries. When global trade expands, we should see economies buying up Treasuries and as a reserve currency, you want people to own your debt. In a way, the Fed can act as a payday lender offering up cash for a small fee when countries need it. The standing repo facility proves that the demand for U.S. Treasuries is not only holding up, it’s increasing.

On the topic of the Fed and QE, Van Metre is less than optimistic that the Fed can satisfactorily handle the current economic environment. His opinion is that the Fed won’t be able to pull the trigger on tapering or tightening and most of the rhetoric today is around keeping the financial markets calm. He notes that while the money supply is increasing, a lot of that money is getting trapped in the banking system and that’s ultimately deflationary. If the Fed does happen to begin tapering asset purchases, he doesn’t see that moving the needle of interest rates. When true quantitative tightening begins, then we may see interest rates rise and money velocity pick up.

Van Metre’s base case today is that the 30-year Treasury bond will go to 0%. In his view, the 1.9% interest rate is just a bonus because the most attractive aspect of them is as a duration play. The justification for his belief is that he expects the Fed will continue purchasing bonds and that will keep downward pressure on rates. We need to see lending growth and we’re just not seeing it to the degree that it can lift inflation. He also believes that the next step for the Fed with regard to QE is buying more bonds at the long end of the curve and it could result in a huge short squeeze. If investors buy Treasuries as a duration play, there’s plenty of upside left, but it would correlate with a big risk-off move in equities.

In terms of building a fixed income position in a portfolio, Van Metre says one should ask themselves what its purpose is going to be. Is it going to be a risk hedge? Is it for income? Is it for defense through duration? Higher yielding options without significant risk are few and far between, but one could consider a combination of U.S. dollars and Treasuries. He reiterates his stand on interest rates moving much lower, so they’re a better capital gains play than an income play. He says his thesis is based on the idea that he doesn’t think the central bank can quit and it doesn’t realize how damaging it can ultimately be to the system.

For investors in general today, Van Metre suggests they temper their optimism and consider ways to protect themselves for outcomes other than their current expectations. He says that everybody is 100% long their own thesis and one of his concerns is that nobody is hedging their own risk or any outcome except their own.

This week our guest will be Eric Basmajian, joining us to discuss bonds, China, inflation, and research. Sign up here.



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