The Astonishing Bond Rush
By
Tim Price Jun 09, 2006
Print this article
The Gadarene rush into long-dated bonds continues to astonish. The UK has just completed the sale of £2.5 billion 50-year Gilts - the Treasury's longest-dated debt issue for more than forty years. The sale comes just three months after France's 50-year bond launch, which was three times subscribed. The yield on 10 year US Treasuries has coasted almost effortlessly below 4%, a level that should make objective investors wince - particularly since US consumer price inflation, year-on-year, stood at 3.5% as at the end of April. This provides international 10-year bond investors with a less than healthy real return currently of less than 0.5% per annum in a currency they might come to regret owning.
Comparably disturbing is the Damascene conversion of Morgan Stanley's respected and prolongedly bond-bearish economist Stephen Roach, who cites the likelihood of a China-inspired Asian economic slowdown as prompting him to change his view 'I now suspect bond yields will stay low for the foreseeable future, and I wouldn't rule out the possibility that they might even drift lower. As Roach indicates, something is definitely 'going on' in the bond market. Whether asset/liability matching amounts to the full story is questionable. If unconstrained fund managers are buying bonds out of desperation at equity market returns, one would like to ask how they're investing ('risking') money in a personal capacity. We know that the 'fundamental' value of Treasuries - whatever that might be - is being manipulated by swing players in the form of Asian central banks. It is a reasonable bet that Treasury prices are also being distorted by the activity of hedge funds, who with all due respect do not necessarily have a reputation for holding financial instruments to maturity. Roach more than most is entitled to his opinion. But rationalising particularly bond prices in an environment wherein so many participants are not investing for the long term but merely parking currency is essentially impossible. Primary dealers ought to know who's doing the buying, but even they may not be privy to the full rationale and any part of that information is unlikely to be shared among competitive market participants.
Yet as Keynes famously quipped 'When the facts change, I change my mind. What do you do, sir? This is certainly not a market environment that rewards dogmatism. Unfortunately, since 'the facts' on the ground are thinner than Victoria Beckham, one can only try and rationalise prices, and it strikes us that if you previously saw little value in Treasuries yielding just a little more than 4%, no amount of fact-shifting makes them inherently more desirable yielding less than that. More to the point, Stephen Roach's sudden quasi-capitulation in front of the bond gods has a hint of the last hold-out finding religion (or running the risk of losing his job - c.f. Phillips & Drew's long-time technophobe Tony Dye during the bubble years) just before the bear market finally starts. While we concede that markets are broadly efficient, and that the bond yield simply is what it is, that doesn't make markets or bond yields necessarily either rational or sustainably 'correct' at any given rate.
There are another couple of reasons for being wary of chasing bond yields at current levels. One is the apparent and recently rediscovered association between bond prices and equity prices. There is no reason why a nominal return investment (i.e. bonds) should be compared to a real return investment (i.e. equities) any more than an elephant automatically bears comparison with a Ferrari. Another is that, as Gillespie Research puts it, 'For people who do not eat, heat, air condition, drive a car or use public transportation, the 'official' US inflation data bears little resemblance to the deteriorating purchasing power of real consumers in the real world. Given the innumerable imponderables to the bond market conundrum, we'd rather shelter in the front end of the yield curve and make selective defensive investments in the stock market, where some yields are genuinely attractive Tim PricSenior Investment StrategisAnsbacher & Co Ltd
Published in
Investments
| More
articles
by
Tim Price
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.