A “bubble” in fixed-income markets is set to burst and will drive funds into stocks, according to Axa Framlington, which oversees $30 billion in global assets.
The market for U.S. Treasury bonds has become inflated as banks exploit benchmark borrowing costs near zero to boost purchases, said Mark Tinker, global equity portfolio manager in London for Axa Framlington, a unit of Paris-based Axa SA.
Investors have been drawn to bonds on rising prices and as a shield against perceived risks to global growth. A sell-off may be triggered if the U.S. Federal Reserve, which has bought Treasuries and government-related debt to hold down yields, doesn’t extend those quantitative easing measures, Tinker said.
“Bonds are in a bubble through a combination of forced buyers, momentum players and a lot of leverage,” said Tinker. “If the U.S. announces a form of stimulus that doesn’t involve the Fed being both provider of liquidity and the buyer of last resort for bonds, the free-money trade disappears. To the extent leveraged players head for the door, the bond bubble will pop, and that means the equity market can bounce.”
Axa Framlington expects some funds will move into stocks linked to emerging economies, where growth rates are higher than for developed markets. The money manager is avoiding shares of financial companies exposed to a potential bond-market collapse, Tinker said.
“Western financials may get some collateral damage,” he said in e-mailed comments. “Emerging-market shares are already somewhat de-coupled as their earnings drivers are local. As confidence returns, it will chase earnings momentum, which is strongest in some of these markets, or in developed-market equities exposed to emerging-markets growth.”
The Fed’s policy of keeping its target for the overnight lending rate near zero since December 2008 has enabled banks to finance purchases of longer-maturity and higher-yielding Treasuries at a low cost, while damping the incentive to lend to businesses. The yield on the two-year Treasury slid to a record 0.45 percent on Aug. 24. The benchmark 10-year yield fell to 2.42 percent the following day, the lowest since January 2009.