Hollande Bonds Without AAA Shine Brighter Than Gold

Credit downgrades, recession and President Francois Hollande’s gaping budget shortfall have done little to prevent French bonds from outshining gold.

Investors who bought French bonds when Standard & Poor’s stripped the country of its top credit rating on Jan. 13, 2012, have chalked up a 12 percent return, about triple the gains of German debt. Gold, touted by some investors as the world’s safest asset and a potential beneficiary when AAA rated governments are downgraded, lost 17 percent in the same period.

The rate on 10-year French government securities tumbled to a record low of 1.659 percent this month. Unprecedented stimulus from central banks, including interest-rate cuts and asset purchases, are eroding yields from top-rated bonds, forcing investors to ignore credit ratings and the shortcomings of Hollande’s economic fundamentals for higher returns. France’s bond market, Europe’s second biggest after Italy’s, also offers investors comfort they can exit the market without difficulty.

“French bonds are fundamentally weak, but they are attracting strong demand,” said Soeren Moerch, the head of fixed-income trading at Danske Bank A/S in Copenhagen. “France may be at risk of further downgrades, but that doesn’t matter much as long as there’s massive amount of money out there seeking returns. France is part of a global story of liquidity boosts and search for yield pick-up.”

Ignoring Ratings

French bonds outperformed Europe’s top-rated government debt this year, gaining 1.4 percent, according to data compiled by Bloomberg and the European Federation of Financial Analysts Societies. AAA rated Germany returned 0.1 percent, the Netherlands gained 0.3 percent and Finland 0.3 percent. France was stripped of its top credit ratings last year by Standard & Poor’s in January and Moody’s Investors Service in November.

France’s 1.42 trillion-euro ($1.83 trillion) market is bigger than the Austrian, Finnish and Dutch government debt markets combined, according to data from respective debt management agencies. Germany’s tradable debt outstanding stands at 1.14 trillion euros.

Sovereign debt yields moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades, and credit-outlook changes, data compiled by Bloomberg in December show. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974. Last year, investors ignored 56 percent of Moody’s ratings and outlook changes and 50 percent of those by S&P, the data showed.

Losing Glitter

While Warren Buffett, the third-richest investor in the Bloomberg Billionaires Index, made the right call on gold when he warned investors to avoid it in his annual letter to shareholders last year, his skepticism on bonds has so far been unfounded. The chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc. told Bloomberg Television this month he was sorry for fixed-income investors with corporate bond yields so low.

Gold prices, which gained the past 12 years in the longest bull run in at least nine decades, has had the fifth-worst performance among the S&P GSCI gauge of 24 commodities since January 2012, when France lost its top credit rating. The S&P GSCI declined 3 percent during that time, compared with a gain of 5.06 percent for government bonds, according to Bank of America Merrill Lynch’s Global Government Index. Corporate bonds returned 11.6 percent.

France’s Chance

“Gold is a good investment at a time when you think the world is in the severe danger, but it started to lose its allure once people stopped jumping at every shadow,” said Frances Hudson, an Edinburgh-based strategist at Standard Life Investments Ltd., which manages about $273 billion.

With the European Central Bank bolstering the region’s finances, the speculation about the demise of the euro has evaporated, aiding debt from countries such as France, she said.

“As people’s confidence that the euro zone will continue to survive goes up, that benefits assets like French bonds, which are still considered high quality, despite the country’s short-term problems,” Hudson said.

The extra yield 10-year French bonds offer investors over equivalent German bunds was 52 basis points as of 12:01 p.m. London time, compared with the average of 29 basis points in the past decade. The yield on French securities maturing in 2023 fell to a record low of 1.659 percent on May 2. The French-German spread rose to 200 basis points in 2011 and was 143 points when Hollande took office in May 2012.

Economic Doldrums

French bonds have outperformed their AAA counterparts in the region even with the country’s economy in one of its worst periods. French gross domestic product shrank 0.2 percent in the first three months of 2013, following a revised 0.2 percent contraction in the previous quarter. The country’s jobless claims rose to a record in March as companies pared payrolls.

Propelled by firings at companies such as Goodyear Tire & Rubber Co. and Alcatel-Lucent, the number of claimants reached an all-time high of 3.2 million. France’s 10.6 percent unemployment rate is the highest in almost 14 years. Its debt as percentage of GDP rose to 90 percent last year from 79 percent in 2009, according to data from Eurostat.

The economic gloom has rendered Hollande the most unpopular French president with his approval rating falling to 24 percent in April, according to a TNS Sofres poll.

Liquidity Rules

A shrinking amount of quality bonds and a market sloshing in cheap money from central banks means demand for assets such as French bonds will be underpinned, said Salman Ahmed, a London-based global strategist at Lombard Odier Investment Managers, which oversees $46 billion.

The number of bonds with top rating has dropped to 3,478 on May 17, from 5,254 five years ago, according to Bank of America Merrill Lynch’s AAA Global Fixed Income Markets Index.

“I’m not saying fundamentals are not important, but at the moment there are other more important factors at play which allow French bonds to behave like a core-market asset,” said Ahmed. “The world is awash in liquidity and investors will have to put that money to work. Rating agencies’ action on major markets is usually a confirmation of what you already knew.”