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Thirty years ago, when I started the graduate program at Morgan Grenfell Asset Management, we shareholders looked down on losers in fixed income. The relationships were boring and no one was particularly hot.
In trade with them, I mean. shame on you! But little did we all know that fixed income – from government securities to corporate bonds – was about to embark on the mother of all decades.
Of course, stocks also did great during that period. The MSCI World index has risen sixfold since I bought my first share by filling out a ticket in 1995. In a pen. Buy 10,000 outdoor Sonys please.
But compare the long-term chart of 10-year government bond yields, say, with the S&P 500 or any other bond and stock market. While stocks carved their way to stardom, bonds gained in a relentless march (as yields fell).
This has always made me think. Have rising stocks or bonds produced more millionaires? Stocks have superior risk-adjusted returns. But fixed income markets employ more people and the asset class is $30 trillion larger.
In the latter, you have the mega-money managers, such as BlackRock or Pimco, who owe their fortunes to the steady decline in bond yields. Or those soccer-field-sized fixed-income trading rooms at investment banks — printing as prices rose.
And all the high-yield credit funds littered with dodgy corporate bonds that would have been in exchange if it hadn’t been for borrowing costs falling year after year? I have friends in that game with villas in Mallorca bigger than Versailles.
Of course, the long decline in bond yields has done more than boost fixed income asset prices. It also turbocharged anything that relied on transmission because it made debt cheaper. Hello private equity, venture capital and real estate riches.
I mention all this to explain why the recent sell-off in global bonds is so important. Yields on 10-year gilts (which rise as prices fall) at 4.8 percent are the highest since 2008. Likewise, U.S. 10-year notes, except for a blip in 2023.
Only yesterday, it seems, everyone thought that the trend was down again. And it’s been a problem for decades. Every jump in yields always prompted the question, is this the one? Has the supertrend of ever-lower yields finally ended?
But it never was. If you think the stock sellers are soaked, the career graveyards are full of fixed income managers calling the top (bottom for yields). Even the bond supremo Bill Gross it never recovered after reducing its sovereign fund to zero in 2011.
If the best investors have no idea about the direction of returns, what the hell are the likes of you or me supposed to think about this latest breakout? For what it’s worth, here’s how I think about it.
When I consider my entire portfolio, which is still 73 percent invested in stocks, I tend to wonder: Is the rise in bond yields a response to good news or bad news?
It seems to me that this is the right question to ask at this point because in the US higher yields have as much to do with increased confidence in Donald Trump’s pro-domestic agenda as other factors.
In such cases, company valuations have nothing to fear from higher borrowing costs, as these will be offset by stronger earnings growth as economic activity accelerates. imam written about this often.
For this reason, I would not expect equity values to rise when yields fall. I’m neutral, in other words. Therefore, my outlook for US stocks has not changed after the rise in yields this week, nor for Japanese stocks.
On the other hand, bond yields can rise for bad reasons. If inflation rears its head in any of its ugly forms, or because investors worry about the country’s indebtedness or its ability to service interest costs.
Is the UK in this camp? Many believe so. I don’t care either way, honestly. If Britain is doing well, then so is my FTSE fund. If not, and the pound falls, the huge exposure to overseas sales somewhat insulates the big British companies. And they’re still cheap.
Indeed, the stormy dollar of late has helped all my dollar-denominated and pound-denominated funds. Hence the solid performance of my portfolio this week. (I’ll double my money by Christmas if this keeps up!)
The lower pound has even helped my sovereign fund gain a few percent when this environment should be bad. Thank goodness I also deliberately invested in shorter-duration securities while everyone is worrying about long-term US yields.
I have always thought that the so-called long end of the curve is too low given the dynamics of the US economy. Meanwhile, I’m also confident, based on history, that if the markets go completely crazy, the Fed will come to my rescue by lowering interest rates.
This disproportionately helps the short-term outcome – where bond prices would rise. I am also comforted by the fact that central banks have what is known as an “asymmetric reaction function” when it comes to stocks.
When stock markets jump 20 percent, policymakers twiddle their pencils. However, if they fall by a fifth, everyone starts screaming (especially the rich) and central banks cut rates very quickly.
So all in all, I’m happy with my portfolio regardless of where this wobble in the bond market ends up. The greatest risk is Great Britain. But even here I win if sterling takes a bath. Such is the negativity though, maybe a contrarian bet is worth a column next week?
The author is a former portfolio manager. E-mail: stuart.kirk@ft.com; X: @stuartkirk__
