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Bonds, Rates, Curves, and Russia
08/15/2014 10:00 am EST
Bond guru John Lekas of Leader Capital Return Fund covers a broad range of financial topics, discussing the state of interest rates, the Fed, the yield curve, multinationals, and a contrarian view on Russia.
Steven Halpern: Our guest today is John Lekas, senior portfolio manager at Leader Capital Return Fund-a bond fund that's ranked number one in its category for the year-to-date as well as for the past one- and three-year periods. Thanks for joining us today, John. How are you doing?
John Lekas: Good, good, how are you?
Steven Halpern: Very good. First, could you tell our listeners a little bit about the fund, the types of returns that somebody would expect from this and perhaps touch on the type of investor that is best suited for a fund like this?
John Lekas: Okay, well, let me just give you the return; so, for the last three years, it's 9.26%. Our one-year number is 8.74% and year-to-date, we're up 5.27%, and so, the kind of investor that's appropriate for this fund is an investor that's concerned about higher interest rates, but at the same time, wants to get paid and understands that we take on credit risk mostly, rather than interest rate risk. That's the kind of investor that would be in that fund.
Steven Halpern: Okay, so what does the 30-Year Treasury say about the market for both bonds and stocks today?
John Lekas: No growth-globally-it says there's no growth. That's sort of the short answer. I've heard the supply/demand argument. I've heard that we're the cleanest dirty shirt, so money comes from overseas, that, in fact, because of the negative interest carry that the ECB set up, people don't want to pay that penalty, and so banks over there are putting money in treasuries, etc., etc.
The bottom line is the 30-year Treasury tells you there's no growth and to enhance that-if you look at the end of, or the tapering of QE3, it should have actually had-the 30-year should, the interest rate should have actually risen on that news and it actually went the other way-meaning the Fed quit buying and interest rates actually went down, so, I mean, that tells you that it's a dominant figure and it's for real.
Steven Halpern: So, what do you believe the Fed is going to do next and what do you believe tapering means for stocks, bonds, and for the economy looking forward?
John Lekas: Well, let me just talk about tapering, I don't think it did anything, it never has. It's just another government debacle, if you will. It doesn't do anything. I'd say similar to the ObamaCare Web sites that were set up; that's about how much good it's done.
All that happened, if you look at excess reserves at the Fed, and the amount of tapering, the numbers are identical, so when they go buy these bonds from the banks, the banks just put that cash in the Federal Reserve. They never lent it out as was the plan, so it really did no good at all.
What do I think will happen, in terms of the Fed raising interest rates and what will they do? They'll do nothing through 2015. Look, right now the dollar is strong, wage growth is weak, you know, talking about US economy wage growth.
There's no point in doing anything, they're getting everything they want and, as a matter of fact, they'd probably like a weaker dollar, so in that vein, theoretically, they get lower rates, I mean-but there's no reason to raise rates here at all-zero.
Steven Halpern: So, you've suggested that the yield curve will flatten. What's the impact of such a flattening on the curve?
John Lekas: That's a great question and it's kind of odd, and I want to preface that a little bit. People always ask us, "Are rates going up or down?" I mean, you hear that question all the time, and that I'm going to answer yes to both rates going down and yes to rates going up.|pagebreak|
So, what that means is the short-end of the curve, meaning short interest rates begin to move up, okay, which we've seen in the three years, gone from 50 basis points to almost 100; it's retraced a little bit, but that has happened recently, and, of course, you've seen the 30-year go down, so rates have gone down on the 30-year, but up on the short-term.
And so what you're getting is, it looks like, kind of like a teeter-totter and eventually that will flatten out. We think that probably the three-year goes to around 2% over the next 12 months, between now and 12 months; we think the 10-year goes to about 2% to 2.25% and the 30-year goes to 2% to 2.25%.
So, normally, curves have three positions. They have normal positions, meaning you have low short rates, higher long rates. Then you have a flat curve, meaning everything is about the same. Then you have inverted curves, where the short rate is actually higher than the long rate, and so inverted yield curves pretty much 100% of the time lead to a recession.
Those are leading indicators, and so, it tends to go kind of in order. You have a normal curve, then it goes flat, then it goes inverted. It rarely just goes from normal to inverted. There's a process to it, if you will.
And so, I think that what we're leading up to is probably a recession in 2016, and that makes sense to me, because we already had our recovery-2009 to now-we've had 85% to 90% of our recovery.
People keep saying the recovery is around the corner, but I think we've already had most of it. You've gotten 75% to 80% of it already, and if you look at normal cycles, they're five to seven years-talking about down cycles as well as up cycles-so I think we're.then the next, probably 2016 is a recession.
Steven Halpern: Now, one area in particular where you hold the bullish outlook is for the large multinational financial firms. In fact, you pointed to companies such as ING, Aeon, and Deutsche Bank as attractive. In light of your other comments, could you expand on that outlook?
John Lekas: Yeah, and let me get clear on that. Now, the reason we hold that paper is because there's a couple, kind of, there's two kinds of floating rate paper. There's paper tied to-in general-the majority of floating rate paper is either Libor or 10-year.
Libor paper is paper that, as the London Interbank operating rate moves up, then your coupon moves up and, in theory, if you bought those bonds at a discount, your bond price would move up, too.
You have bonds tied to the 10-year, so if the 10-year moves up, right, then the coupon you have moves up, in theory, so does your bond price.
Most of the 10-year floating paper was issued by European banks denominated in US dollars, and so we have gone from 32% in Europe down to about 10% of our portfolio and it's almost all in floating rate 10-year paper.
And what that does is it gives us a ballast in the event that I'm wrong on my views and rates do go up-we're definitely prepared for that-and it gives us a nice balance in the portfolio, so that's predominantly what those multinational banks are all about. That's why we hold those specifically.
Steven Halpern: Finally, from a very speculative standpoint, you've suggested that Russia could be developing as an attractive investment opportunity despite the political concerns. Could you share your thoughts on that?
John Lekas: Okay, I want to give you a little history on Ukraine, specifically, because that's really what caused the opportunity in Russia. Look-and I just want to be clear on this-I think Putin has done a good job down there. I mean, it's unfortunate they shot that plane down, but let's kind of start from the beginning.|pagebreak|
Ukraine had about $4 billion of bonds maturing, so they had a problem, they needed some help. Europe came in around March of this year and offered them a little less than a billion, which means they would have gone into default for sure, which means they couldn't have accessed the capital market and they would have starved, so it was really a false promise.
Europe didn't want Ukraine, and the reason for that is because they'd had Cypress, they'd had Greece, and they'd had some other problem countries, and they didn't want another weak sister in the ECB's belly, if you will, because they were teetering on borderline economic growth anyway. They didn't want another anchor weighing them down, so they really took a pass on helping Ukraine.
Putin stepped up and said, "I'll give you $16 billion, but what I need is for it to be a Russian domicile," in essence. Obama then came along-the United States came along and intervened in this process, why, I have no idea-because it was really Europe and Russia.
I don't know what business it was of the United States, but we came along and the IMF, got the IMF to pony up $24 billion and that is really-I'm really giving you the short scenario-so, in the end, Putin doesn't have to pay the $16 billion, he's going to keep Crimea, you know, again, Europe didn't want Ukraine.
They didn't want to pay for it and now Putin doesn't have to pay for it, so who ended up paying for it? Half the IMF is the US taxpayers. Yeah, taxpayers just got saddled with, really, a poor country in Europe for whatever reason-I still can't figure it out.
But Putin doesn't really want the rest of Ukraine. It's just going to be a subsidized situation, so I think, in the end, it's a non-strategic country. Nobody really wants it and I think Putin will ultimately move away from it. The UN will come in and straighten that around and all those Russian investments will be a home run for us.
Talking about it, fundamentally, if you look at it, I'm just going to use an example: Gazprom trades on a forward P/E of 2.5. Gazprom, their oil and gas company, last year, made more money than Exxon. I don't think people fully appreciate that.
Gazprom earned $35 billion, Exxon only earned $34 billion, so Gazprom trades on forward P/E of 2.5; Exxon, 12.5. That's a huge difference, and they're really similar companies. They're both global multinational players.
The Russian MICEX trades on a forward P/E of only five. We trade on a forward P/E of 18 to 19, talking about the US, and it's a pure play in oil and gas, nothing complicated, so we like situations that are not complicated, very straightforward, huge asset bases.
We like asset bases and we like to buy things cheap, so right now we're getting 8% to 10% on a current yield and I think the upside is 10% to 15% when this all goes away, which I think will be sooner than later.
So I think, ultimately, we make 20% to 25% on our money there, and for a bond fund, I think that's just terrific. And it's all in investment grade dollar-denominated, non-ruble paper, so, for us, it's a tremendous opportunity.
I'm not saying pick any name, but you could pretty much buy any of the large-cap companies-if they're $14 billion to $80 billion-whether it's Gazprom, or Rosneft, or VTB, or Sberbank, or, take your pick.
I think it all ends up paying pretty well, so that's on my view on Russia. It's just-I'm not saying it's an easy opportunity, but Ukraine will be resolved way sooner than later.
Steven Halpern: Fascinating view on a controversial topic. We really appreciate your insights. Thank you for taking the time today.
John Lekas: No problem and I appreciate you giving us the opportunity and I hope it helps your readers.
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