Lost Decade for Bonds Looms With Growing Return for Equities
U.S. Treasuries are now providing less than half the yield of stocks, giving investors little reason to keep the three-decade bull market in bonds alive as housing starts, consumer confidence and corporate profits point to an improving economy.
While 10-year Treasuries yield 2.61 percent, up from a 2013 low of 1.61 percent on May 1, the aggregate earnings yield of stocks in the Standard & Poor’s 500 Index (SPX) was 6.4 percent of the index’s price level, Federal Reserve data compiled by Bloomberg show. Even after the selloff in bonds, the four percentage point gap is more than double the average of 1.9 points since 2000.
With the Fed saying it could start tapering its $85 billion of monthly bond purchases later this year, investors from Leon Cooperman’s Omega Advisors Inc. to BlackRock Inc. are avoiding longer-term Treasuries, concerned that returns will be depressed for years to come. Money managers foresee the end of a rally that began after former Federal Reserve Chairman Paul Volcker vanquished inflation in the early 1980s.
“The lost decade for bonds has begun,” Howard Ward, the chief investment officer at Rye, New York-based Gamco Investors Inc., which oversees $36.7 billion, said in a June 19 telephone interview. “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.”
With consumer confidence approaching a six-year high, housing starts increasing to 2008 levels and corporate profits double what they were five years ago, investors withdrew $9.1 billion from fixed-income mutual funds and exchange-traded funds in the week ended June 5, the second-highest total in more than 20 years, according to Denver-based Lipper.
JPMorgan Chase & Co., the most-active underwriter of corporate bonds since 2007, earlier this month joined Barclays Plc, Bank of America Corp., Morgan Stanley and Goldman Sachs Group Inc. in recommending stocks over most bonds as equity returns outpace company debt by the most since at least 1997.
The Bank of America Merrill Lynch U.S. Corporate & High Yield Index’s 2.6 percent loss this year compares with a 12.8 percent gain for the S&P 500 Index, including reinvested dividends. Treasuries have lost 2.8 percent, according to the Bloomberg U.S. Treasury Bond Index. (BUSY)
Fed Chairman Ben S. Bernanke told reporters in Washington on June 19 that policy makers are prepared to begin phasing out its bond buying later this year and halt purchases around mid-2014 as long as the economy meets the central bank’s forecasts. Bonds around the world fell along with stock markets.
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 and now a Bloomberg View contributor, 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.”
Treasury 10-year yields rose last week by the most in a decade, surging 40 basis points, or 0.4 percentage point, according to Bloomberg Bond Trader prices. Yields extended gains today, rising eight basis points to 2.61 percent as of 11 a.m. in New York, after reaching 2.66 percent, the highest since August 2011.
The selloff wasn’t limited to the U.S. Yields on 10-year German bunds soared 21 basis points last week to 1.73 percent. U.K gilts increased 34 basis points to 2.4 percent.
“Liquidity today is king and what we’re getting is cascading liquidity failures,” Mohamed A. El-Erian, chief executive and co-chief investment officer at Pacific Investment Co., said today in a Bloomberg Radio interview with Tom Keene and Michael McKee. “When you change the liquidity paradigm, what you get is massive technical unwinds and that speaks to the volatility.”
Globally, bonds of all types have lost 1.5 percent in 2013, even after accounting for reinvested interest, Bank of America Merrill Lynch’s Global Broad Market Index shows. The gauge hasn’t had a down year since 1999, when it fell 0.26 percent.
Prospects for less Fed stimulus also hit stocks last week. The S&P 500 fell 2.1 percent to 1,592.43, down from the record high of 1,687.18 on May 22. The benchmark Stoxx Europe 600 Index 3.7 percent, while the MSCI World Index dropped 2.9 percent. The S&P dropped 1.5 percent today.
Profits for companies in the S&P 500 will jump more than 10 percent in each of the next two years after almost doubling since 2008, the average of more than 11,000 analyst estimates compiled by Bloomberg show.
Earnings gains of that magnitude would send yields to 8.3 percent assuming no change in the stock index. The S&P 500 now trades at a multiple of 14.7 times this year’s profit forecast.
“The stock market multiple is low relative to interest rates,” Leon Cooperman, the chairman and chief executive officer of New York-based hedge fund Omega Advisors, with $8.4 billion under management, said in an interview on Bloomberg Television’s “In the Loop” with Betty Liu on June 20. “There’s scope for rises,” he said, adding that a fair level for the S&P 500 is between 1,600 and 1,700.
Bonds have their backers. Treasuries will be the best performers for the next few months, according to Jeffrey Gundlach, manager of the $41 billion DoubleLine Total Return Bond Fund. The fund returned 4.35 percent in the 12 months ending of June 21, beating 91 percent of its peers. It has lost 0.1 percent this year, better than 88 percent of competitors.
“Government bonds are also caught up in price deflation of assets and commodities, but I just think if bond yields rise further then it seems crystal clear to me equities and commodities will tank,” Gundlach said in a telephone interview on June 20. “Therefore, you’ll lose less in Treasuries if rates rise than many other asset classes.”
Slow inflation is also a lure to Treasuries. The Fed’s preferred gauge of consumer prices, the personal consumption expenditure index, will average 0.8 percent to 1.2 percent this year and climb 1.4 percent to 2 percent in 2014, the central bank reported June 19. Its target is 2 percent.
Fed economists revised their forecasts for U.S. economic growth, saying on June 19 that gross domestic product will rise 2.3 percent to 2.6 percent this year, compared with a previous estimate of 2.3 percent to 2.8 percent. The rate next year might be as high as 3.5 percent. Unemployment will drop to as low as 6.5 percent by the end of 2014, the central bank said.
The difference between Treasury 10-year yields and the annual rate of inflation, a measure known as the real yield, touched 1.17 percent on June 21, the highest since March 2011, after falling to negative levels as recently as March.
“Those that are selling Treasuries in anticipation that the Fed will ease out of the market might be disappointed unless we have inflation close to 2 percent,” Bill Gross, the manager of the world’s biggest fixed-income fund at Pimco, said in a June 19 interview on Bloomberg Television’s “Street Smart” with Trish Regan and Adam Johnson.
Gross has been advising investors to buy Treasuries while the Fed continues to purchase debt, even as he says that the 30-year bull market for bonds is over.
His $285 billion Total Return Fund (PTTRX) had 37 percent of its holdings in Treasuries in May, down from April’s 39 percent, the most since July 2010. The fund returned 0.7 percent the past year, beating 74 percent of its peers. It has lost 3.71 percent in 2013, beating just 12 percent of competitors.
“Real growth to lower unemployment below 7 percent is a long shot over the next six to 12 to 18 months,” Gross said.
While investors flee bonds, Laszlo Birinyi, one of the first money managers to tell clients to buy stocks before the bull market began in March 2009, said the S&P 500 could climb to 1,700 as more people move into equities.
“We still haven’t seen the real rush to equities,” Birinyi, president of Birinyi Associates Inc. in Westport, Connecticut, said in a telephone interview on June 19. “We’re still confident this market has a long ways to go.”
Equity investors may reap unusually high returns during the next five years, according to a May 8 report from the Federal Reserve Bank of New York. Stocks are inexpensive as measured by the Fed Model, which compares the earnings yield for equities with government bond yields.
The spread touched a record high of 6.6 percentage points in March 2009, data compiled by Bloomberg showed. The gap shrank to 0.3 percentage point in December 2009 in the early stages of the bull market while earnings declined as the recession drew to an end in June of that year.
With 10-year yields rising, “equities represent better value than Treasuries, particularly on the longer end of the curve,” Rick Rieder, chief investment officer for fundamental fixed-income at BlackRock, said in a telephone interview on June 20. “We’ve seen the lows on interest rates.”
Rieder recommends government debt due in less than five years, estimating that 10-year Treasury yields will move closer to 3 percent next year. New York-based BlackRock is the world’s largest money manager, with $3.94 trillion of assets.
An investor buying 10-year Treasuries at the current yields would gain 0.1 percent if they reached 3 percent at the end of 2014, Bloomberg data show. Rates on the benchmark securities touched a record low of 1.379 percent in July.
“The only way bond yields will come down and revisit those lows is if the economy relapses,” David Rosenberg, the chief economist at investment advisers Gluskin Sheff & Associates Inc. in Toronto, said in a telephone interview on June 18. “The odds of that happening at least in the next year have come down significantly. The economy has managed to crawl through.”
Rosenberg is shorting, or betting against, government debt in favor of high-quality corporate and speculative-grade securities. He’s also buying stocks of banks and insurers.
Treasuries yields are still below the average 3.57 percent for the past decade. The 10-year term premium, a model that calculates the risk of holding longer-duration securities, rose above zero on June 19 for the first time since October 2011. A positive reading suggests the securities are at fair value.
“The stock market would not be where it is without the bond market where it is,” Rosenberg said. “The Fed is using the bond market as a tool to generate a higher stock market and it’s certainly working. The secular bull market is over.”
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