Vero de Rugy sends me this link from Bloomberg:
Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an “exceedingly rare” event in the history of the bond market.
I am skeptical but do not have any particular counter. What do you all know about this? Is this a temporary liquidity effect? Are there other embedded rights in these securities?
Well, note that the securities whose interest rates dropped below treasuries’ largely have pricing power in periods of inflation. (JNJ and ABT are pharmaceuticals with patents, PG has brand power, LOW is a low-cost producer, BRK.A is run by a man who made his fortune off of buying companies with inflation-resistance, and RY is Canadian). They’re presumably still higher rates than TIPS. Additionally, most (all but LOW, I believe) also have international exposure. So functionally, you’re getting extremely strong US corporations with clean balance sheets and good management who are more resistant to inflation than US government bonds.
Given the polycentric nature of authority that has evolved for the average resident of the United States, it was only a matter of time before this happened. I would hesitate to draw too many inferences from this, however, since Berkshire after all has far fewer obligations than does our treasury.
There’s less cross asset category arbitrage than you might expect in high quality bond markets. Investment mandates are often very restrictive. If many managers have to hold mostly (or entirely) highly rated corporate bonds, and if Treasuries are not part of their guidelines, those managers may value performance against their mandate more than they value a few basis points of yield.
Plus asset prices are only efficient within the bounds of profitable arbitrage, and shorting scarce Berkshire Hathaway bonds is somewhere between expensive and impossible.
Maybe the market sees BH bonds as lower risk than government debt? Or that government debt is a unique product and is oversupplied?
Anyway, this suggests that treating sovereign debt as the expected 0 risk return is wrong.
MattM:
Yes, and if you look at the bonds in question, it is the *current yield* that was 3.5 bps lower, not YTM (YTM was *far* lower).
However, the coupon payment is higher on the Berkshire note…
See:
http://reports.finance.yahoo.com/z2?ce=5814850145511576017555
vs.
http://reports.finance.yahoo.com/z2?ce=4915552143561497016253
I think part of the answer is that these are just *offers* to sell, does anyone have evidence there were actual transactions at these prices?
The Treasury bond market is much larger than the corporate bond market, and thus is more efficient and has much smaller bid/ask spreads. Without someone biting and purchasing the bond, I believe this is just the lack of a motivated seller, and a market that is not clearing?
I have no idea what you’re talking about. A 1.4% 2year note with current yield 89bps?
What world do you live in?
MattM:
You’re right, I hadn’t reread the article today and forgot they quoted that, and was looking at an even worse discrepancy where the current yield was lower than treasuries.
But right now, Berkshires have both a lower yield offer and a higher yield bid than the equivalent Treasury.
Does anyone know that an actual transaction took place at such prices, or is this just the lack of liquidity that it seems to be?
Actually, the article is broadly right. Ignoring the very small differences in yields created by different coupons in such a short note, there is lots of evidence that treasuries are yielding relatively more than they ever have. This is also reflected in the collapse of corporate spreads of all grades to record-tight levels. It isn’t just a reflection of some myopic euphoria on the part of corporate bond traders– it also reflects higher relative treasury yields.
The best proof of this is to look at 10yr LIBOR (swaps) spreads. Swap spreads are extremely liquid, homogeneous across the curve, and because they are not cash bonds, cannot go “special”. They have no special features, warrants, optionality, etc that can distort the analysis of cash bonds. 10 yr swap spreads have traded between 40 bps and 140 bps over the past 20 years. They are currently at 3 bps. In other words, 10yr US treasuries are currently only 3 bps richer than a generic AA credit.
Most bond market participants believe that this is due to the huge increase in bond issuance expcetd from the US government. Especially once the Fed stops buying debt, rates are likely to rise much more– and there could be more coprorate bonds that trade through treasuries.
Well, Warren has de-commoditized cash in insurance and finance. It doesn’t seem possible in the dollar bond market, but maybe so.
i don’t get it. it’s not about inflation, it’s about default risk. and how can the USA have a higher default risk than BRK, PG or LOW?
i didn’t look at the math MattM was commenting on – is it just a quirk there?
Kid Dynamite -
functionally, a government with a fiat currency cannot default. They can just print money to pay off their debt. This results in inflation, which is why I listed inflation as the primary concern.
It’s functionally concern about the fiscal condition of the government (as many of us have pointed out), but just looks at the mechanics of what an actual “default” would look like.
Taken to extremes, look at Zimbabwe. They had massive, massive external bank and IMF debt, but they didn’t default, they just printed boatloads of Zim dollars. Inflation as a percentage shot up (at its peak, inflation as a percentage exceeded the number of stars in the universe or atoms in the universe or something ridiculous like that). The country basically turned to a barter economy and then pegged to the dollar. That’s more like what a default would look like in this day and age, except perhaps not as drastic (as hyperbolically shortsighted and “dumb” as Washington is, they are better than Mugabe).
It means that Warren Buffett is a divinely inspired prophet (of profits).
I am right now looking at Bloomberg, and my screen says the Berkshire bonds in question are yielding 1.18%, up from .91% last Friday. As of Friday they were trading through Treasuries, giving them a negative spread. That in turn is a direct reflection of the market’s belief that Berkshire was a better credit risk than the U.S. government over the next two years. Today that’s not the case, perhaps because all of the publicity caused some owners of Berkshire bonds to reconsider their relative attractiveness.
Negative spreads on corporate bonds can and do occur, though rarely, and they are indeed indicative of the market’s distrust of sovereign debt.
Liquidity is very unlikely to explain the negative spread, especially now that Treasury is issuing boatloads of bonds of all maturities.
Possibility one.
So much money going into safe corporate bond that are suppose to be about as safe as US securities but yield more that in fact they have driven the yield down.
Possibility two.
While the government can print money to cover the debt, it in fact won’t. Some group in congress refuses to authorize increasing the debt ceiling or authority to print the money because it wants certain political concessions.
I suspect one because of two was a serious possibility I expect yields to be much higher.
These notes are due in Feb. 2012: that indicates the yields were set by the secondary market. As others have noted, the secondary market for corporate debt is actually not at all an efficient market (for that matter, BRK.A shares are pretty illiquid and probably don’t trade very efficiently either).
Let’s put things in perspective. As I write this, Bloomberg is reporting U.S. government 2-year notes are selling at 0.96%. When the earlier article was written, BRK corporate bonds were selling at 0.89% compared to 0.925% for government debt. Hardly a sign of coming apocalypse.
Moreover, let’s suppose the U.S. government defaults on short-term debt within the next two years. What do you suppose would happen to Berkshire Hathaway if the U.S. government defaults? Do you really think BRK does not hold billions of dollars of cash and government bonds? This looks to be a pretty weird market inefficiency. Somebody overpaid for BRK debt and is probably kicking themselves right now.
It isn’t just a reflection of some myopic euphoria on the part of corporate bond traders– it also reflects higher relative treasury yields.
Sure, but treasury yields are higher relative to what? If relative to corporate bonds, that’s begging the question. If indeed spreads between corporate bonds and treasuries have been narrowing, it’s clearly an indication people suddenly think corporations are less likely to default. Might this have something to do with an implicit bailout guarantee from the government?
Especially once the Fed stops buying debt, rates are likely to rise much more– and there could be more coprorate bonds that trade through treasuries.
In that case, it would be great to work in corporate finance at one of these companies. Once your bonds start trading through treasuries, borrow to the hilt, buy up treasuries of the same maturity and then hit the golf course. Sure, if the government default you are in trouble but that’s true regardless of whether you hold huge amounts of money directly in treasuries or not.
Great digging, Ricardo. Of those trades, just one — the one at 12:16:02 — is lower than the 0.93% yield on Treasuries quoted in the Bloomberg report. Do you have any idea where Treasuries were trading at 12:16 on 3/18?
A lot of the value of the BRK shares and bonds are a measure of the value of Buffett himself. As for me, I think he’s getting old, and with BRK.B becoming part of the S&P 500, I sold most of mine. I predict that when he dies, or becomes too ill to work, the share price will crash. I started with 2 shares, and that’s what I still have – the split let me cash out.
Regarding the Berkshire bond, I don’t know about the TRACE data, but if I’m reading it right Bloomberg shows what looks like a $35,000 odd-lot trading at an $87.50 dealer markup late in the day on March 19. $87.50 reduces the 9bp gross yield by 13bps and it shows negative. Presumably the dealer would have charged something like $87.50 if he bought a Treasury for you anyway. The substantive trades recently were all at 5 to 20bps over. A lot of media hype over nothing.
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