The three-decade bull market in bonds may morph into a lost decade.
In the 2000s we had a lost decade for stocks, which started the period with nosebleed-valuations, thanks to dot-com mania and Irrational Exuberance. Investors who bought and held experienced crashes in 2001-2002 and in the wake of the panic of 2008. Bond investors, by comparison, saw largely consistent gains in their holdings, especially with the Federal Reserve pursuing an emergency low-rate policy for the better part of five years since Wall Street melted down.
But bond mutual funds and exchange-traded funds have experienced a combined outflow of more than $47 billion in June, the worst month on record, according to TrimTabs. Treasuries fell 2.8 percent this year through June 21, according to the Bloomberg U.S. Treasury Bond Index. By comparison, the MSCI All-Country World Index of shares returned 5 percent during the period, including reinvested dividends. Globally, bonds of all types have lost 1.5 percent in 2013, as tracked by Bank of America Merrill Lynch’s Global Broad Market Index; the reading has not had a down year since 1999.
All of which could add appeal to the equity side of the portfolio ledger. JPMorgan Chase, Barclays, Bank of America, Morgan Stanley, and Goldman Sachs are recommending stocks over most bonds.
“The lost decade for bonds has begun,” Howard Ward, chief investment officer at Gamco Investors, told Bloomberg’s Susanne Walker. “Stocks are likely going to be the asset class of choice over the course of the next 10 years. Now that the tide has turned and the economy is doing better, investors in bonds are going to have a hard time making any money.”
In its annual report, the Bank of International Settlements (BIS) calculated that U.S. bondholders would lose more than $1 trillion if yields across maturities were to rise 3 percentage points. “As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care,” the BIS said. “Clear central bank communication well in advance of any moves to tighten will be critical in this regard.” Last week, benchmark Treasury yields shot up the most in 10 years after Federal Reserve Chairman Ben Bernanke said the central bank may begin tapering its bond-buying program this year.
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, Jim O’Neill, the former chairman of Goldman Sachs Asset Management, said in a June 11 interview on Bloomberg Television. “When the game starts to change with central banks, it is inevitable bonds are going to suffer.”
Even after their recent taper-induced climb, Treasury yields remain below the average 3.57 percent for the past decade. Meanwhile, analyst estimates have profits for companies in the S&P 500 on track to gain more than 10 percent in each of the next two years, after almost doubling since 2008.
A renaissance for the equity culture? A Great Rotation? Sell it all and go to cash? It all comes down to how investors process the growing realization that they can, in fact, lose money in bonds.