Background
Fixed Income investors have enjoyed more than 30 years of falling yields and rising prices. These are two sides of the same coin; if yields rise then prices fall or vice-versa. Industry jargon talks about changes in yields rather than changes in prices.
As an indication of how good it has been for fixed income investors, the FTSE 100 index hit 6,930 on 30th December 1999 and on 5th December 2014 the index value was 6,742, a fall of 3%. In contrast, the 3.5% War Loan, an undated government bond, rose from £71.98 to £100.48 over the same period, an increase of 40%.
“Devastation” Forecast
“There will be ‘devastation’ in the bond market next year when the US Federal Reserve raises interest rates” says Bill Eigen, manager of the JPM Income Opportunity fund. He says he is the most nervous he has been during his 24-year career in fixed income.
The threat of further economic woes in the eurozone and the lack of inflation in western markets may have suggested to many that interest rates will stay ‘lower for longer’ which justifies record low bond yields (record high prices). Eigen thinks such an assumption is dangerous as he believes many areas of the bond market are about to crash. “We are at a point where it is really dangerous in the bond market. It’s not funny anymore”.
The US Lead
Ten-year US treasuries currently yield 2.2%, which Eigen says is a signal that the bond market is now ‘broken’. He argues that prices no longer reflect economic realities, given that the US economy has grown at around 4.3% over the last two quarters, inflation is around 2%, unemployment is down to 5.7% and quantitative easing has stopped.
He says that overly cautious investors are ignoring economic fundamentals as they view US treasuries as good value – only because they offer a higher yield than their Japanese and eurozone equivalents. As a result of such complacency, he is preparing for an all-out crash over the short-term by holding close to 60% of his absolute return fund in cash.
Flight to Safety (as at 05.12.14)
Comparisons of a corporate bond and a similarly dated gilt shows how over-bought is the gilt. The 8% Treasury 2017 stands at £121.395 while the 7% Provident Financial 2017 is only £107.025. The 5% Treasury 2018 stands at £112.74 while the 6.5% Enterprise Inns 2018 stands at £104.45. Realistically, is there greater safety to justify the difference?
So What?
In Bill Eigen’s view, investors in long-only fixed income funds have nowhere to hide from an imminent crisis. The figures suggest that short to medium dated direct corporate bonds may be the sought-after hiding place. Sadly, most platforms will not service them.
Disclaimer: This material is published by Raymond James Investment Services Limited (RJIS) for information purposes only and should not be regarded as providing any specific advice. Opinions constitute our judgement of this date and are subject to change without warning.