Fixed Income Asset Classes Outperform During a Balance Sheet Recession

The implications of the balance sheet recession go well beyond public policy mistakes.  As we’ve seen over the last few years, misunderstanding the disease has also resulted in massive portfolio mistakes (mostly by those who expected high inflation to hurt bonds).  In a recent note Nomura touched on the BSR and its impact on fixed income:

“One reason that balance sheet recessions tend to last a long time is that deleveraging is not an overnight process. Leverage accumulates over time, and takes a while to unwind. As we discussed earlier, Japanese corporates began deleveraging in 1990 and have continued ever since. European and North American non-financial corporates began deleveraging around 2000.

This has implications for asset returns. Deleveraging is bad for equities, but good for credit. Figure 2 shows how that effect played out in Japan. Equities delivered negative excess returns over an extended period of time. Credit outperformed, along with other fixed income asset classes such as FX carry and government bonds.”

Source Nomura


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • whatisgoingon

    If I understand this correctly, the fact that the Nikkei underperformed has to do with the fact that the Japanese government bounced between deficit spending and austerity (pushing the economy into/out of recession) which impacts corporate profitability. The US to date has avoided this kind of equity underperformance since 2009 because of deficit spending (and provided deficit spending continues SPX need not underperform like the Nikkei has)?

  • Cullen Roche

    Two big things with Japan:

    1) They had a corporate BSR. So their companies were the root cause of the balance sheet recession. Not households like in the USA.
    2) Their govt didn’t spend over 5% of GDP until 6 years into the crisis. The USA did it within 6 months.

    So, I like to say the USA is Japan on fast forward.

  • Martin T

    Very good points from Nomura, on top of that, while the Japanese government took ages in cleaning up banks balance sheet and the consolidation of the banking sector took a lot of time as well. From an asset allocation perspective, it still makes sense to be long credit versus equities from a European point of view.



  • Blobby

    Lots of discussion at present about Zombie companies in the UK.
    Im not so sure many lessons have been learnt from Japan!

  • Scott Krisiloff

    If corporate entities delever, but the government continues to accumulate debt, has deleveraging occurred?

  • Apj

    Yes, the corporate sector has delevered. So have households, in spades. The point being, the private sector has delevered. In a sovereign currency country such as the US, the fact that government has run higher deficits (in $US) is largely irrelevant. It is supportive of growth when other sectors are detracting from growth. This is what they are supposed to do, unless of course they are comfortable with engineering recession. In a non-sovereign currency country such as the Eurozone countries, there is far less distinction because they are unable to adjust policies to address imbalances, do not have their own central banks, and therefore be one more of a credit bet themselves. So it depends on what monetary arrangements the country you are referring has …

  • Ryan Melvey

    I wonder what the body count is on the amount of bears who have been slaughtered by the huge bull market in Treasuries.

    If you don’t try to understand MR or a similar framework none of it makes sense.

  • Scott Krisiloff

    APJ, are you making the argument that private debt is something that needs to be repaid, but public debt can be ignored?

    Why can the government just run as large of deficits as it wants, and how is that “largely irrelevant” to aggregate leverage? In aggregate, there has been continuing accumulation of leverage in the US since 2008. Public debt gets passed through to private citizens through taxation or inflation/negative interest rates, so private citizens’ de-leveraging has been completely offset by the government’s actions.

    If you believe that we are in a balance sheet recession and that the only cure is de-leveraging, we have not made much progress at all. Non-financial credit market debt as a % of nominal GDP is mostly unchanged over the last 5 years.

  • Apj

    I am making the statement that Households and corporates are fundamentally different to government in a monetary system such as US … Or UK, Australia, Japan etc. Countries like these have no problem rolling their debt. EZ countries do, and there is a reason for this.

  • yourejammingmeup

    quick noob question – what are some good ways to get long on credit?

  • Martin T

    You can go long credit using some ETFs or alternatively by doing some bond picking via retail size issues.



  • Geoff

    If you want pure exposure to credit, go long a corporate ETF and short a Treasury ETF of similar duration.

  • InvestorX

    Hmmm, maybe Scott has a point, because as he said, govt debt is passed thru to the household sector via taxes or inflation. Maybe parts of HH sector may hedge themselves against inflation via assets (bubbles), but then there is a huge redistributive effect. So it may look like over the short-to-mid term that govt can run as much deficit as it wants, but over the long-term it has negative effects (unless the govt spending has some long-term benefits like much needed infrastructure as opposed to bridges to nowhere).

    Another effect I have come up, is that the share of govt of GDP grows, so potential GDP declines over the long-term. There is no satisfactory MR / MMT answer to that issue, as far as I can see.