From Treasuries to bunds, and corporate bonds to mortgage securities, the world's fixed-income market is poised for its best year since 2002 as slow growth, tame inflation and record low interest rates create an almost perfect environment for debt investors.
From Treasuries to bunds, and corporate bonds to mortgage securities, the world's fixed-income market is poised for its best year since 2002 as slow growth, tame inflation and record low interest rates create an almost perfect environment for debt investors.
Bonds have returned 6.57 percent in 2010, including price appreciation and reinvested interest, a pace that would total 7.94 percent for the year, based on Bank of America Merrill Lynch's Global Broad Market Index. That would be the most since the measure, which tracks more than 19,000 securities with a par value of $36.9 trillion, surged 8.92 percent in 2002. The Standard & Poor's 500 gained 7.73 percent, including dividends.
Money is pouring into debt as central bankers refrain from raising rates as inflation slows. That's allowing the U.S., U.K., Germany and Japan to fund record budget deficits, private equity firms to refinance debt loads used in buyouts and mortgage rates to fall to record lows.
“We are in a Goldilocks environment for fixed income that will last for the next five to 10 years,” said Scott Minerd, who helps oversee more than $100 billion in New York as Guggenheim Partners LLC's chief investment officer. “Rates will stay low until inflation comes back and unemployment turns around.”
Internet Boom
Fixed-income mutual funds have attracted $555.4 billion in the two years ended Sept. 30, more than the $496.9 billion that went to equity funds during the height of the Internet boom in 1999 to 2000, according to data compiled by Bloomberg and the Washington-based Investment Company Institute. Some $38.4 billion has flowed out of stock funds this year.
Bond yields average 2.18 percent, below the average of 3.81 the last 10 years, as measured by the Bank of America Merrill Lynch index. For a government or company, that means annual interest savings of $16.3 million on every $1 billion borrowed.
Some of the biggest bond firms say the best may be behind as the Federal Reserve prepares to print more money and flood the world with dollars in an effort to avoid deflation.
Bill Gross, who oversees about $1.24 trillion as co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., said last week the 30-year bull market is almost over because “certain maturities can't go much lower in yield.” He compared the government bond market to a Ponzi scheme, dependent on finding more investors so borrowers can roll over an ever rising amount of debt.
Record Bids
So far, that hasn't been a problem for U.S. President Barack Obama, U.K. Prime Minister David Cameron, German Chancellor Angela Merkel or Japan Prime Minister Naoto Kan.
Investors placed $5.7 trillion bids for the $1.9 trillion of notes and bonds sold by the U.S. government this year, according to data compiled by Bloomberg. The almost 3-to-1 ratio is a record, even though the U.S. budget deficit exceeded $1 trillion for a second year. In Japan, the sale of 30-year securities by the government on Oct. 14 drew bids for 5.4 times the amount offered, the most in eight years.
“The trend in yields is still downward,” said Lacy Hunt, executive vice president at Austin, Texas-based Hoisington Investment Management Co., whose Wasatch-Hoisington U.S. Treasury Fund has returned 7.3 percent on average the past five years, beating 96 percent of its peers. “‘Until the economy turns around, we won't see any inflationary pressure, which means fixed-income can rally further.”
Slower Growth
The International Monetary Fund in Washington forecast the world economy will expand 4.2 percent next year, compared with 4.8 percent in 2009. Though slowing, that's still better than the average of 3.69 percent from 2000 through 2008.
Government bonds have returned 5.6 percent this year, versus 0.9 percent in all of 2010. Of the major economies, the gains have been led by the 8.3 percent return for Treasuries, followed by U.K. gilts at 7.9 percent, German bunds at 7.7 percent and Japanese bonds at 2.9 percent.
Greece, Ireland and Portugal are the exceptions, with each losing at least 5 percent and showing there are limits to investors' tolerance for budget deficits.
Companies are among the biggest beneficiaries of record low government yields and global growth, giving investors the confidence to finance even the riskiest borrowers. Standard & Poor's said Oct. 29 it expects the global default rate to drop to 2.4 percent by September 2011, from 7.5 percent now and the peak of 11.4 percent in November 2009.
‘Looking for Yield'
Company bonds from the U.S. to Europe and Asia have returned 9.7 percent this year on average, according to Bank of America's Global Broad Market Corporate & High Yield Index. Debt rated CCC and lower have gained 17.7 percent.
“Investors are still looking for yield,” said Rick Rieder, chief investment officer of fixed income at New York- based BlackRock Inc., the world's largest money manager, overseeing $3.45 trillion. “The need for yield in a shrinking fixed-income atmosphere and the activities of the Fed will pressure yields lower, but not with the same vigor as it has been so far this year.”
Corporate bond sales worldwide total $2.65 trillion this year, following a record $3.87 trillion in 2009, according to data compiled by Bloomberg. Issuance of junk bonds in the U.S. is already at an all-time high of $231.1 billion.
Bonds from Harrah's Entertainment Inc., taken private for $30.7 billion in 2008 by Leon Black's Apollo Management LP and David Bonderman's TPG Capital, were the best performing of the 50 biggest debt issues in the Bank of America Merrill Lynch U.S. High Yield Master II Index last month.
Harrah's Rallies
The Las Vegas-based company's debt returned an average 6.99 percent. In March, Chief Executive Officer Gary Loveman arranged to extend $5.5 billion of maturities to 2015.
Securities tied to home loans have joined the rally, returning 6.3 percent on average, compared with 5.76 percent for all of last year, based on Bank of America Merrill Lynch's Mortgage Master Index. The gains have helped drive the average 30-year mortgage rate down to a record low of 4.19 percent last month, according to McLean, Virginia-based Freddie Mac.
Developing economies delivered some of the top returns. The JPMorgan Emerging Markets Bond Plus Index is up 16.3 percent this year, following a 26 percent gain in 2009.
High unemployment rates in developed nations and a banking system that is reluctant to extend loans means the global recovery “runs the risk of not being sustained,” IMF Chief Economist Olivier Blanchard wrote in an introduction to the Washington-based organization's World Economic Outlook.
‘Decoupling' Risk
“If growth stops in advanced economies, emerging-market economies will have a hard time decoupling,” he said.
Commercial and industrial loans at U.S. banks fell to $1.23 trillion last week, from a peak of $1.62 trillion in October 2008, according to Federal Reserve data.
Central bankers are taking steps to keep the recovery from the worst financial crisis since the Great Depression on track. Fed Chairman Ben S. Bernanke has kept its benchmark rate in a range of zero to 0.25 percent since December 2008, while the Bank of England's is at 0.5 percent, the European Central Bank has a target of 1 percent and Japan's is virtually zero.
The Fed meets Nov. 2 and 3 and will likely say that it will resume buying Treasuries to inject cash into the economy after consumer prices, excluding food and energy, rose 0.8 percent in September from a year earlier, the slowest rate since the 1960s. The central bank bought $1.7 trillion of government debt and mortgage securities in the first round of so-called quantitative easing between October 2009 and March 2010.
Estimates for the ultimate size of asset-purchases range from $1 trillion at Bank of America-Merrill Lynch Global Research to $2 trillion at Goldman Sachs Group Inc. Economists at both firms agree the Fed will start by announcing $500 billion this week.
‘Keeping Rates Low'
“History has proven the Fed can keep long-term interest rates low for an entire decade if it believes it is warranted in order to ensure the viability of long-term economic recovery,” Guggenheim's Minerd wrote in a note last week to clients. “If the Fed is indeed committed to keeping rates low as long as necessary for the economy to recover, which I believe they are, it would once again mean higher yields are not on the horizon anytime soon.”
Minerd pointed to the 1940s, when 10-year Treasury yields averaged 1.99 percent, amid the Fed's first asset purchases that were designed to finance World War II and spark the economy. The yield on the benchmark 2.625 percent note due August 2020 fell almost two basis points to 2.59 percent as of 12:15 p.m. in London, according to BGCantor Market Data.
“A lot of the quantitative easing is priced in and real rates are not very generous, but in the current atmosphere this is not a good argument against investing in fixed income,” said Christine Todd, a managing director and head of the group that oversees $26 billion in tax-sensitive fixed-income portfolios at Standish Mellon Asset Management Co. in Boston. “We are going the right direction and rates would be going the other way if the Fed didn't step in but the Fed can't reverse the economy alone.”
