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Thirty years ago when I started on the grad programme at Morgan Grenfell Asset Management, we equity kids looked down on the losers in fixed income. Bonds were dull and no one was particularly hot.
At trading 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 multi-decade runs.
Sure, equities have done brilliantly over the period too. The MSCI World index is up six-fold since I purchased my first share in 1995 by filling in a ticket. In pen. Buy 10,000 Sony at the open, please.
But compare a long run chart of 10-year Treasury yields, say, with the S&P 500, or any other bond and equity bourse. While stocks have whipsawed their way to glory, bonds have gained in a relentless march (as yields fell).
This has always made me ponder. Have rising equities or bonds produced more millionaires? Shares have superior risk-adjusted returns. But fixed income markets employ more people and the asset class is $30tn bigger.
In the latter you have the mega-money managers, such as BlackRock or Pimco, that owe their riches to ever-falling bond yields. Or those football pitch-sized fixed income trading rooms at investment banks — printing presses as prices rose.
And all the high-yield credit funds rammed with dodgy corporate bonds that would have defaulted had it not 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 did more than lift prices of fixed-income assets. It also turbocharged anything reliant on gearing as debt cheapened. Hello the fortunes made in private equity, venture capital and real estate.
I mention all of this to explain why the recent sell-off in global bonds is so important. Ten-year gilt yields (which rise as prices fall) at 4.8 per cent are the highest they’ve been since 2008. Likewise, US 10-year notes, save for a blip in 2023.
Only yesterday, it seems, everyone reckoned the trend was down again. And this has been the rub for decades. Any jump in yields has always prompted the question: is this the one? Is the supertrend of ever-lower yields finally over?
But it never was. If you think short sellers of equities are suckers for pain, career graveyards are crammed with fixed income managers calling the top (the bottom for yields). Even bond supremo Bill Gross never recovered from reducing his Treasury holdings to zero in 2011.
If the best investors are clueless on the direction of yields, what the hell should the likes of you or I make of this latest rout? For what it is worth, here is how I am thinking about it.
When considering my whole portfolio, which remains 73 per cent invested in equities, I usually ask myself: is a rise in bond yields a response to good news or bad news?
This seems to me to be the right question to ask at the moment because in the US higher yields have as much to do with increased confidence in Donald Trump’s pro-domestic agenda as they do other factors.
In such instances, company valuations have nothing to fear from higher borrowing costs, as these will be offset by stronger revenue growth as economic activity accelerates. I have written about this often.
For that reason I wouldn’t expect equity values to rise when yields decline, either. I’m neutral, in other words. Hence my outlook for US equities hasn’t changed after the surge in yields this week, nor has it on Japanese stocks.
On the other hand, bond yields can rise for bad reasons. If inflation raises a head in any of its ugly forms, or because investors worry about the indebtedness of a country or its ability to service its interest costs.
Is the UK in this camp? Many believe so. I don’t care either way, frankly. If Britain is fine, so is my FTSE fund. If not, and the pound cracks, a huge exposure to overseas sales insulates large British companies somewhat. And they’re still cheap.
Indeed, the storming greenback of late has helped all my funds that are priced in dollars and translated into sterling. Hence the solid performance of my portfolio this week. (I’ll double my money by Christmas if this keeps up!)
A lower pound has even helped my Treasury fund gain a couple of per cent when this environment should be hurting. Thank goodness too that I’m deliberately invested in shorter-dated securities, whereas it’s US long-term yields everyone is fretting about.
I have always thought the so-called long end of the curve was too low given the dynamism of the US economy. Meanwhile, I’m also confident, based on history, that if markets totally freak out, the Fed will rush to my aid by cutting policy rates.
This disproportionally helps the short end — 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 equities.
When stock markets jump 20 per cent, policymakers twiddle their pencils. Should they fall by a fifth, however, everyone starts screaming (especially the rich) and central banks cut rates real quick.
So in all I am happy with my portfolio irrespective of where this bond market wobble ends up. The biggest risk is the UK. 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. Email: stuart.kirk@ft.com; X: @stuartkirk__