Bonds Are Having Their Best Year Since 2002

From Treasuries to German bunds, and corporate bonds to mortgage securities, the world's fixed-income market is poised for its best year since 2002 as slow growth, tame inflation, and record low interest rates in many major economies create an almost perfect environment for debt investors.

Bonds have returned 6.57 percent in the first 10 months of 2010, including price appreciation and reinvested interest, a pace that would total 7.94 percent for the full year, based on Bank of America Merrill Lynch's (BAC) Global Broad Market Index. That would be the most since the measure, which tracks more than 19,000 securities with a par value of $36.9 trillion, surged 8.92 percent in 2002. The Standard & Poor's 500-stock index gained 7.73 percent, including dividends, over the same time.

Money is pouring into debt as central bankers refrain from raising rates while inflation slows. "We are in a Goldilocks environment for fixed income that will last for the next 5 to 10 years," says B. Scott Minerd, who helps oversee more than $100 billion as Guggenheim Partners' chief investment officer.

Some of the biggest bond firms warn that fixed-income investors may suffer as the Federal Reserve prints more money and floods the world with dollars in an effort to avoid deflation. Bill Gross, who oversees about $1.24 trillion as co-chief investment officer at Pacific Investment Management Co., said in late October that the 30-year bull market is almost over because "certain maturities can't go much lower in yield." He compared the government bond market to a Ponzi scheme, dependent on finding more investors so borrowers can roll over an ever-rising amount of debt.

So far, that hasn't been a problem for some large government borrowers. Investors submitted $5.7 trillion in bids for the $1.9 trillion of notes and bonds sold in auctions by the U.S. government this year, according to data compiled by Bloomberg. The 3-to-1 ratio is a record. In Japan, the sale of 30-year securities by the government on Oct. 14 drew bids for 5.4 times the amount offered, the most in eight years.

"The trend in yields is still downward," says Lacy Hunt, executive vice-president at Austin (Tex.)-based Hoisington Investment Management, whose Wasatch-Hoisington U.S. Treasury Fund has returned 7.3 percent on average over the past five years, beating 96 percent of its peers. "Until the economy turns around, we won't see any inflationary pressure, which means fixed income can rally further."

The bottom line: As slow economic growth in most major economies helps to keep inflation and interest rates low, bond investors are reaping solid returns.

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