Wall Street’s biggest bond dealers are telling clients to shift from most fixed-income markets into U.S. stocks as deepening concern the Federal Reserve will pare unprecedented stimulus fuels the worst debt losses since 2011.
JPMorgan Chase & Co. (JPM), the most-active underwriter of corporate bonds since 2007, last week joined Barclays Plc (BARC), Bank of America Corp. (BAC), Morgan Stanley (MS) and Goldman Sachs (GS) Group Inc. in recommending stocks over most bonds as equity returns outpace company notes by the most since at least 1997. The Bank of America Merrill Lynch U.S. Corporate & High Yield Index’s 0.73 percent loss this year through June 11 compares with a 15.1 percent gain for the Standard & Poor’s 500 Index. (SPX)
Securities from Treasuries to junk bonds are showing their vulnerability to a potential pullback from Fed actions that have pumped more than $2.5 trillion into the financial system since 2008. Debt “remains most tied up with the search for yield” and faces more volatility than equities as interest rates rise, JPMorgan strategists led by Jan Loeys said in a June 7 report.
“We’ve now seen a little bit of a rotation out of bond funds,” said Hans Mikkelsen, head of U.S. investment-grade credit strategy at Bank of America in New York. “You could see a very quick change in asset allocation on the retail side that the institutional side can’t keep up with it.”
Dollar-denominated bonds of companies from the most to least creditworthy plunged 2.2 percent through June 11 from May 22, when Fed Chairman Ben S. Bernanke told Congress the central bank could slow stimulus efforts during its next few meetings if the economy shows signs of sustained improvement. The S&P 500 lost 1.7 percent in the same period.
Volatility in Treasuries as measured by Bank of America Merrill Lynch’s MOVE Index has soared 68 percent to 82.3, from a 2013 low of 48.87 on May 9. The gauge is based on prices of over-the-counter options on Treasuries maturing in two to 30 years. In the equities market, the Chicago Board Options Exchange Volatility Index (VIX) rose 40 percent in the period.
The market response to “mere talk” of the Fed slowing its bond purchases provides “an idea of where the vulnerabilities are to an actual reversal in monetary policy,” said the strategists at JPMorgan, which had the top-ranked fixed-income team by Institutional Investor magazine in 2012. “To be overweight equities to broad fixed income is the most obvious implication.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreased 2.3 basis points to a mid-price of 85.2 basis points as of 10:41 a.m. in New York, according to prices compiled by Bloomberg.
The index typically falls as investor confidence improves and rises as it deteriorates. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, decreased 0.9 basis point to 16.1 basis points as of 10:42 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of Citigroup Inc. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4 percent of the volume of dealer trades of $1 million or more as of 10:46 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Bloomberg Global Investment Grade Corporate Bond index has gained 0.32 percent this month, paring the decline for the year to 1.45 percent.
Barclays asset-allocation strategists recommended investors be “overweight” U.S. and Japanese stocks “over the medium-term, as we anticipate a gradual migration out of expensive bonds,” according to a May 28 report. Overweight allocations mean investors hold more of the assets than their benchmarks.
Morgan Stanley said for the first time in March that it preferred stocks over debt in a March global strategy outlook.
Bank of America generally favors equities over bonds and moved to “underweight” investment-grade corporate notes in their total-return asset allocation recommendations in February, Mikkelsen said in a telephone interview. Goldman Sachs favors stocks over both a three- and 12-month period, is bearish on government bonds and forecasts “close to zero” returns for corporate credit, its strategists said in a May 21 report.
“You can’t run away from bonds, but equities are cheaper,” said Andrew Feltus, a money manager who helps oversee $36.7 billion in U.S. fixed-income assets at Pioneer Investment Management Inc. in Boston.
Corporate bonds globally have gained an average 10.1 percent annually since 2008, when the Fed embarked on an unprecedented program of buying bonds and holding its interest rate target near zero to ignite economic growth. That compares with annual gains of 16.7 percent for the S&P 500.
Companies have since sold $5.7 trillion of notes as relative yields on dollar-denominated debt plunged 5.7 percentage points to 2.31 percentage points through June 11, Bank of America Merrill Lynch index and Bloomberg data show. JPMorgan, Bank of America, Goldman Sachs and Morgan Stanley are among the six most-active underwriters of the debt.
Speculation has mounted since Bernanke’s comments last month that the Fed will soon start scaling back its stimulus efforts.
San Francisco Fed President John Williams said last week that a “modest adjustment downward” in the asset purchases is possible as “early as this summer.”
“We do not see these warnings as simply loose talk that costs lives, but more a kind of fire drill for risk managers on what the end of easy money could do to financial markets,” JPMorgan credit strategists said June 7 of the talk by Fed officials. “In our model portfolios, we added to our overweight of equities, and have greatly reduced the credit overweight versus safe debt to a small position, focused on shorter-duration credit.”
The global economy is “in the early stages of the recovery of the equity culture and perhaps the end of a 30-year growing love affair” with bonds, said Jim O’Neill, former chairman of Goldman Sachs Asset Management in a June 11 interview on Bloomberg Television.
Investors yanked a record $4.8 billion from U.S. high-yield bond funds last week and pulled $850 million from investment-grade funds, the first weekly redemption since December, according to a Bank of America report on June 6.
U.S. private pension funds and insurance companies pushed their allocation to equities to 45 percent in the first quarter, the highest proportion since 2007, as they bought $13 billion of stocks while selling $10 billion of bonds, JPMorgan data show.
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