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Thirty years ago when I started the grad program at Morgan Grenfell Asset Management, we equity kids were looking at the losers in fixed income. The bonds are tight and no one is particularly hot.
To trade with them, I mean. Shame on you! But little do we all know that fixed income – from government securities to corporate bonds – is about to embark on the mother of all multi-decade runs.
Sure, equities have done well over time too. The MSCI World index has risen sixfold since I bought my first share in 1995 by filling out a ticket. In pen. Buy 10,000 Sonys in the open, please.
But compare a long-term chart of 10-year Treasury yields, say, with the S&P 500, or any other bond and equity bourse. While stocks were making their way to glory, bonds were gaining ground (while yields were falling).
This always makes me think. Did the rise in equities or bonds produce more millionaires? Shares have a higher risk-adjusted return. But fixed income markets employ more people and the asset class is $30tn bigger.
Later you have mega-money managers, like BlackRock or Pimco, who owe their fortunes to ever-falling bond yields. Or those football pitch-sized fixed income trading rooms of investment banks — printing presses as prices rise.
And all those high-yield credit funds filled with bad corporate bonds that might fail if it weren’t for borrowing costs falling every year? I have friends in the game who have villas in Mallorca bigger than Versailles.
Of course the long decline in bond yields is more than driving up the prices of fixed-income assets. It also turbocharges anything that relies on gearing as debt shrinks. How about fortunes made in private equity, venture capital and real estate.
I mention all this to explain why the recent sales of global bonds very important. Ten-year gilt yields (which rise as prices fall) at 4.8 percent are the highest since 2008. Likewise, US 10-year notes, save for a blip in 2023.
Just yesterday, it seems, everyone assumed that the trend had fallen again. And this is the rub for decades. Any jump in yields always prompts the question: is it so? Is the supertrend of perpetually low yields finally over?
But never. If you think short sellers of equities are pain suckers, the career graveyards are full of fixed income managers calling the top (below for yields). Even bond supreme Bill Gross never recovered from reducing its Treasury holdings to zero in 2011.
If the best investors don’t know the direction of yields, what the hell are people like you or me to do with this latest loss? For what it’s worth, here’s how I think about it.
When considering my entire portfolio, which remains 73 percent invested in equities, I often ask myself: is the rise in bonds a response to good news or bad news?
This for me is the right question to ask at the moment because in the US higher yields are related to more confidence in the pro-domestic agenda of Donald Trump as they do for other reasons.
In such instances, the company’s estimates are not afraid of higher borrowing costs, because they will be offset by stronger income growth as economic activity accelerates. I’m there wrote about it usually.
For that reason I don’t expect equity values to go up when yields go down. I am neutral, in other words. So my outlook for US equities has not changed after the surge in yields this week, nor has it for Japanese stocks.
On the other hand, bond yields may rise for bad reasons. When inflation rears its head in any ugly form, or because investors are worried about a country’s debt or its ability to service its interest costs.
Is the UK in this camp? Many believe that. I don’t care either way, frankly. If Britain does well, so will my FTSE fund. Otherwise, and the pound cracks, a large exposure to overseas sales insulates the major British companies. And they are cheap.
In fact, the stormy greenback later helped all my funds priced in dollars and translated into sterling. Hence the strong performance of my portfolio this week. (I’ll double my Christmas money if this keeps up!)
A lower pound has even helped my Treasury fund gain a few percent if this environment should hurt. Thanks also to me deliberately investing in shorter-dated securities, while it is the US long-term yield that everyone is concerned about.
I have always thought that the so-called long end of the curve is too low because of the dynamism of the US economy. Meanwhile, I’m also confident, based on history, that if the markets get completely spooked, the Fed will be quick to help me by cutting policy rates.
This disproportionately helps in the short end – where bond prices go up. I am also comforted by the fact that central banks have what is called an “asymmetric reaction function” when it comes to equities.
When stock markets jump 20 percent, policymakers shake their pencils. If they fall to a fifth, however, everyone starts screaming (especially the rich) and central banks cut rates real fast.
So all in all I’m happy with my portfolio regardless of where the bond market shakes out. The biggest risk is the UK. But I won’t win if sterling takes a bath. As negative as that is, though, maybe a contrarian bet is worth a column next week?
The author is a former portfolio manager. Email: [email protected]; X: @stuartkirk__
