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Gary Shilling Slams Fed’s ‘Zeal for Yield’

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Perma-bear and AdvisorOne contributor A. Gary Shilling,  president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation,” is taking aim at Fed policy in a piece written Thursday for Bloomberg, noting that Federal Reserve Chairman Ben Bernanke and Co.’s low rates are luring yield seekers onto “thin ice.”

Gary Shilling“Some investors are pursuing the safety of federally insured deposits,” Shilling (left) begins. “Others are dissatisfied with low nominal and negative real returns and are moving further out on the risk spectrum in their zeal for yield, regardless of whether they understand the additional risk they are incurring.”

Just as Alan Greenspan downplayed the possibility of a housing bubble prior to the collapse in 2008, Bernanke acknowledged that the central bank’s “nontraditional policies,” namely quantitative easing, “could induce an imprudent reach for yield by some investors and thereby threaten financial stability.” But he downplayed the threat, saying, “We have seen little evidence thus far of unsafe buildup of risk or leverage.”

Shilling doesn’t buy it, noting that he sees “lots of potentially unsafe buildups.”

“Consider the rush into junk bonds, depressing their yields and spreads versus Treasuries. So much money has poured into below-investment-grade debt that it now takes real skill to default. In the third quarter, junk-rated companies sold $94 billion in debt compared with $25 billion in the third quarter of 2011. Nonetheless, the global recession will hype defaults even though many low-rated companies have a cushion of safety from prefunded debt.”

“Zeal for yield” has pushed the returns on junk municipal bonds to just 3.15 percentage points more than investment-grade issues, the narrowest gap in two years, he adds.

He also notes that master limited partnerships are usually backed by energy pipelines and other investments that produce steady revenue from long-term contracts. They pay out 90% of their earnings, and are able to promote current returns of about 10% annually to investors. But in reaction to the zeal for yield, private-equity firms, with the assistance of Wall Street banks, are unloading fracking sand, gas stations and coal mines into these limited partnerships and attracting investors with “mouthwatering yields.”

“Slightly less risky are commercial mortgage-backed securities,” he concludes, “which are in such demand that their yields are at narrower spread compared with their benchmark than when real estate was still booming and risks were ignored. Such securities backed 75% of all commercial real-estate lending at the earlier peak, and are gaining in prominence again. Credit-rating companies, however, are warning that the loan quality of such mortgage-backed paper is weakening, possibly putting investors at risk.”


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