People are seen on Wall Street in front of the New York Stock Exchange (NYSE) in New York City, the United States, on March 19, 2021. REUTERS/Brendan McDermid/File Photo
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LONDON, Sept 21 (Reuters) – With prices falling like a stone and central bank tightening in full swing, buying bonds may seem confused – but perhaps that very confusion is reason enough in itself.
The financial markets are full of often-contradictory old adages and pearls of “wisdom” — how to be greedy when others are fearful, but also not trying to catch a falling knife.
There is a grain of truth to all of them, but mostly they apply to different types of savers, traders or investment managers with different horizons and risk appetites.
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Right now, anyone who plays bonds as a “safe” alternative to falling stock prices is likely to get burned as inflation and interest rates soar and bond indexes plummet along with stocks.
Even ETFs invested in US Treasury bonds with relatively short maturities between 1-3 years are down for both the third quarter and year-to-date, with ETFs in longer-duration Treasury bonds between 7 and 10 years now more than losing 15% so far in 2022.
Continued to be battered by a rising dollar, foreign government bond indices are down nearly 24% in dollar terms – worse than the S&P500 (.SPX)’s 19% year-to-date turnaround.
Far from portfolio buffers, these types of moves are making bonds meat and drink for hedge funds.
Speculative funds that play futures markets are playing bonds as one of the “big shorts” of the year — with net bearish bets on two-year government bonds rising to their highest level in almost 18 months last week and net shorts on longer-dated paper the highest level in a year when the Federal Reserve meets this week.
Rudyard Kipling’s poetic admonition to keep your head up when everyone around you is losing your head – which has also become tired old investment advice – then falls to longer-term money managers more interested in yield and yield than price.
With higher yields, the expected annual returns have improved significantly over the coming period. And while stock prices have fallen and become cheaper on many models, their relative value versus bonds is not.
Bad Year for BondsGlobal Asset Returns
‘AGE OF CONFUSION’
In its latest annual report on expected returns for 5 years, Dutch investment manager Robeco describes the period ahead as the “Age of Confusion”.
For Robeco, markets have been disoriented by several recent shocks – compounded by a lack of understanding of inflation and shifts in monetary policy, as well as an ongoing debate as to whether the so-called Great Moderation of structurally low inflation and interest rates had actually ended.
This heightened uncertainty is reflected in almost double the volatility in analyst forecasts of global earnings estimates for the coming 12 months compared to pre-Covid levels.
But stocks remain historically expensive and arguments about the lack of alternatives are now harder to make, the assessment says.
Robeco estimates that the rise in “risk-free” government bond yields means an estimated 3% equity risk premium for a euro-based investor is now below the long-term average of 3.5% for the first time in its 12-year annual release .
“In part, this is because we expect a level shift in consumption volatility that warrants a higher medium-term equity risk premium than is currently being reflected by the market.”
While it’s not exactly a clear call to buy bonds – where yields and term premiums are still below ‘steady-state’ estimates – Robeco managers view them as ‘significantly cheaper’ and have a 5-year forecast of the Annualized yields on euro-hedged developed market government bonds revised upwards by 1.5 percentage points. Expected stock returns have been cut by a quarter point.
“Big claims of paradigm shifts require a heavy burden of proof. We do not find sufficient evidence to conclude that we are close to a tipping point where inflation in developed economies spirals out of control due to reflexivity,” Robeco concluded, acknowledging several competing scenarios.
Others choose bonds more directly to protect mixed investments.
Societe Generale’s global asset allocation team this month upgraded bonds by about 5 percentage points to 33% in its multi-asset portfolios and increased US bonds to a quarter of the total allocation – to hedge the additional weight in euros as they are reluctant to rise an already high 53% dollar exposure even further.
“The credibility of the Federal Reserve will continue to anchor inflation expectations below 2%,” wrote the SG team. “Indeed, we consider US Treasuries to be one of those rare assets that have already priced in many of the risks ahead.”
Confused? Nearly 4% nominal US Treasury yields over two years, or more than 3.5% now for 10 years, may just be enough to rebuild the mixed 60/40 stock/bond portfolios in 2022.
As Cesar Perez Ruiz, Pictet Wealth Management’s chief investment officer, said earlier this month, 2023 could be the “revenge of the 60/40”.
Reuters Poll – US Treasury Yield OutlookRobeco Chart on Asset Allocation History
The opinions expressed here are those of the author, a columnist for Reuters.
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by Mike Dolan, Twitter: @reutersMikeD; Edited by Chizu Nomiyama
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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias under the Trust Principles.
Mike Dolan
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