Kyle Bass: I Wouldn't Be Long Stocks, Short Japanese Government Bonds, Bet On Higher Rates Cheaply (CNBC Video)

Kyle Bass, managing partner at hedge fund Hayman Advisors, was on CNBC today giving free institutional advice on how to make big money risking very little capital. Remember credit default swaps on sub-prime mortgage CDOs? Kyle Bass, along with hedge fund managers John Paulson and Michael Burry, also bet against sub-prime mortgage pools using CDS (8/2007 Forbes article, 6/2007 investment letter, 12/2007 Bloomberg) and even warned former Bear Stearns co-workers about the risks he saw in the mortgage market in 2006 (See the FCIC hearing below).

This time Bass is betting against Japanese Government Bonds (quotes) using interest rate derivatives or CDS. He thinks JGBs are mispriced, unsustainable and susceptible to the "Keynesian endpoint". I'm sure U.S. Treasuries will be vulnerable at some point in the future. I can see the Government hearings now. Here's a WSJ article from December 2009:

"Traders are betting against Japan's debt in myriad ways. Some bearish traders are entering into option contracts betting on "forward rates", or the direction of Japanese yields. These options are among the most heavily traded of the commonly used bearish tools, so some beginners to the game are embracing them. The downside is investors can find themselves exposed to big losses if yields fall further.

Others buy credit-default swaps, derivative contracts that serve as insurance to protect against a default of Japan's debt. The cost to insure $10 million of Japanese bonds is about $70,000 a year for five years. That price has climbed from less than $50,000 since October.

Still others are buying more exotic instruments, such as "CMS caps," also called constant-maturity-swap caps, and "swaptions." These interest-rate options reward a buyer if Japanese rates climb over the next few years, but limit downside because there is only a one-time upfront payment.

Mr. Bass has purchased protection on about $12 billion of Japanese bonds, according to a person close to his firm, a move that is costing him about $6 million, a skimpy price because most investors still doubt the trade will succeed. If 10-year yields, currently at 1.3%, rise to 3% or so, Mr. Bass won't make that much; but if they hit 4%, he would make about $125 million on his $6 million investment. He will make at least $125 million for each subsequent percentage-point rise, according to people close to the firm."

Now back to the CNBC videos. Bass thinks we're witnessing a 100 year structural change and the U.S. won't escape ZIRP (zero percent interest rate policy) until a "painful restructuring" occurs. He made an interesting point that life insurance companies and pension funds are being forced to reach for yield while growth slows, which he thinks is a bad idea. He believes GDP growth will be revised to 1% or lower.

In the second video he brought up the European stress tests, JGBs and his outlook for stocks, "given my outlook on the world, I don't know how you could be long stocks". He thinks a global "restructuring" in Europe and Japan combined with deflation (M3 contracting) would tip global GDP growth into negative territory.

Bass is short sovereign debt in Europe and Japan and is long U.S. bank debt situations, distressed liquidations, U.S. mortgages and high yield corporate debt. The first two videos are from CNBC.com and the the third is an FCIC hearing (Financial Crisis Inquiry Commission).







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