After the legions of market savants missed out on hundreds of billions of dollars in gains this year anticipating a tumble in bonds, you'd think they would have found another target. You'd be wrong.
After the legions of market savants missed out on hundreds of billions of dollars in gains this year anticipating a tumble in bonds, you'd think they would have found another target. You'd be wrong.
Given the chance to speculate on declines in only one asset class, 45% of investors, traders and analysts in a quarterly Bloomberg Global Poll conducted last week picked debt securities of some type as their top choice, more than three times the percentage who selected gold. Among the options, most chose government debt and junk bonds over assets that also included stocks, commodities, currencies and real estate.
While the resilience of Treasuries to speculative-grade corporate bonds and emerging-market sovereign debt surprised almost everyone this year, bond skeptics are still convinced that a strengthening U.S. economy will ultimately lead to higher yields as the Federal Reserve lifts interest rates. The poll respondents were bearish on bonds even as they said a lack of inflation, which has propelled the biggest global bond returns in a decade, was a greater threat to the economy than inflation.
“For rates to go a lot lower in the U.S. from the point they are trading at right now, things would have to go very bad in terms of growth,” Raul Fernandez Diaque, a money manager at Internacional de Capitales SA de CV, a hedge-fund firm that oversees almost $1 billion, said. The survey participant said putting on a bearish wager on Treasuries “is something on our radar.”
TOP PICK
If they could only buy one asset today, 30% of Bloomberg poll respondents picked stocks in developed nations. That's the most among any asset and more than twice the percentage of real estate, the second-most popular long pick.
Wall Street prognosticators were just as bearish on bonds at the start of the year, bolstered by signs U.S. demand would allow the Fed to end its unprecedented stimulus and lead the central bank to raise interest rates from close to zero.
Based on a Bloomberg survey of economists and strategists in January, they foresaw yields on the 10-year Treasury note, the benchmark for trillions of dollars of securities, rising to 3.44% by year-end, from 3.03% at the end of 2013.
Instead, Treasuries advanced as lackluster wage growth, turmoil from the Middle East to Russia and even the outbreak of Ebola caused investors to pour into the debt. That's caused the forecasters to lower their year-end estimates for 10 straight months as yields on the 10-year note plummeted 0.71 percentage point this year to 2.32% last week. The yield was 2.29% Monday as of 12:13 p.m. in Tokyo.
BOND GAINS
Gains haven't been limited to Treasuries. Yields across Europe plunged to records, with the benchmark German bund falling below 1%, as the specter of deflation emerged.
At the same time, emerging-market sovereign debt and junk-rated corporate bonds rallied as steps by central banks around the world to suppress borrowing costs and bolster their economies pushed investors into higher-yielding assets.
Bonds worldwide have returned 6.4% this year, the most since 2002, according to the $45.7 trillion of debt securities included in the Bank of America Merrill Lynch Global Broad Market Index. That's equal to about $281 billion in price gains and interest over that span.
With average bond yields globally falling to a record 1.51% last month, financial professionals in almost every corner of world are showing renewed confidence that debt securities are finally ripe for a selloff.
UNLOVED ASSETS
When asked which asset they would short if they had the opportunity to choose just one, 20% of participants in a poll of 510 Bloomberg customers picked government debt, making it the most-popular choice, while 17% said junk bonds.
Including those who selected emerging-market debt and investment-grade corporate securities, 45% chose to short bonds of one type or another. Gold, which has fallen 14% from its high in March, was picked by 12%. Five percent answered none of these or not sure.
Short selling is a strategy employed by traders to profit from falling prices. The poll was conducted on Nov. 11 and Nov. 12 by Selzer & Co., a Des Moines, Iowa-based firm, and has a margin of error of plus or minus 4.3 percentage points.
Based on the median estimate of the Fed's own officials released in September, the central bank's target overnight rate will reach 1.375% by end of 2015. The Fed has held the rate between zero and 0.25% since 2008.
Investors are pricing in that the first rate increase will come in 10 months, data compiled by Morgan Stanley show.
The lack of inflation in the U.S. may keep the bear market in bonds that investors foresee from materializing any time soon, said Jeffrey Klingelhofer, a money manager at Thornburg Investment Management Inc., which oversees $89 billion.
The risk that prices will rise more slowly or fall was cited by 47% of Bloomberg poll respondents as the greater threat to the U.S. economy, versus 37% who said inflation. That's a reversal from the Bloomberg poll in July, when 55% viewed inflation as the more imminent risk.
The Fed's preferred gauge of inflation has fallen short of its 2% target for more than two years, while bond yields imply that consumer prices may only rise an average of 1.56% per year over the next five years, from an annual average of 2.1% as recently as June.
With monthly wages rising 0.1% or less five times this year, U.S. consumers are generating little of the price pressures that would erode the value of fixed-rate payments. That's helped 30-year Treasuries, the most sensitive to losses when inflation rises, return more than 20%.
'VERY UNLIKELY'
“The global backdrop makes it very unlikely” for bonds to sell off, Mr. Klingelhofer said. As for the bears, “they'll be right — one of these days.”
The U.S. economy posted the strongest six months of growth in a decade, recovering from a first-quarter contraction, while employers are adding the most jobs since 1999. The improving labor market and the cheapest gasoline since the end of 2010 have bolstered Americans' views of the economy to the highest level in almost seven years.
“In many ways, the economic performance this year has been pretty good,” Stephen Stanley, the chief economist at Amherst Pierpont Securities, said. His 2015 estimate for 10-year yields of 4.25% matches the highest of 81 forecasts in a Bloomberg survey. “To me, there is maybe an even better case” for higher yields than a year ago.
With yields so low, investors are increasingly wary that bonds issued by the neediest companies aren't compensating them enough for the risk that credit quality will deteriorate even as the economy improves, said David Wyatt, a bond salesman at First Winston Securities in Winston-Salem, N.C.
Yields on junk bonds average 6.37% globally, below the five-year average of 7.55%, index data compiled by Bank of America show. Since 1998, speculative-grade yields have averaged closer to 10%.
A majority of bond investors in a Bank of America survey this month said the default rate on junk-rated debt may rise as high as 4% in the next year. That's above the current 1.7% rate tracked by Moody's Investors Service.
“It doesn't pay you to buy the junk right now because if the music stops, the junk bond is going to get hammered considerably more” than higher-quality debt, Mr. Wyatt, who took part in the Bloomberg poll, said.
While financial professionals are bearish on bonds, they see few signs of a slowdown in equities.
MORE CONFIDENT
That's even after the Standard & Poor's 500 Index (SPX), the benchmark gauge for American common equity, surged to a record last week and extended a bull market that's tripled the value of U.S. stocks since March 2009.
In Europe and Japan, which have lagged behind the U.S., equities have also rebounded in the past month as their central banks have taken more aggressive steps to boost their economies.
“There's confidence in the U.S. economy,” Richard Sichel, chief investment officer at Philadelphia Trust Co., which oversees $2 billion, said. “The central banks in Europe and Japan are doing a lot and there's a general feeling that will lessen volatility and enhance prospects to make money going ahead. There's value in the comfort of developed markets” stocks versus bonds.
