Who Goes to Cash Shows Extent Bonds Will Become Bear MarketMary Childs and Daniel Kruger
Investors who poured $1.26 trillion into bond funds in the past six years pulled out record amounts of cash last month, leaving the world’s biggest fixed-income managers struggling to stem the flow.
The funds saw $61.7 billion of withdrawals as money market mutual fund assets rose $8.17 billion in the week ended June 25, according to TrimTabs Investment Research and the Money Fund Report. Bank of America Merrill Lynch’s Global Broad Market Index dropped 2.9 percent in the past two months, the most since the inception of the daily gauge in 1996, as Federal Reserve Chairman Ben S. Bernanke laid out possibilities for reducing the $85 billion in monthly bond purchases supporting the economy.
Market bears say losses are just getting started because yields barely exceed inflation, leaving little relative value in bonds as the global economy improves. Pacific Investment Management Co., BlackRock Inc. and DoubleLine Capital LP, which together oversee about $6 trillion in assets, said the worst is already over because the securities are fairly valued.
“We are at a definite inflection point,” Richard Schlanger, who helps invest $20 billion in fixed-income securities as a vice president at Pioneer Investments in Boston, said in a telephone interview on June 28. “If this thing continues in this vein, people are going to throw in the towel and you’re going to get this pain trade. And the markets can’t take it. They’d rather see a gradual rise in short-term rates versus a precipitous rise.”
Pioneer has held a smaller percentage of Treasuries in 2013 than is contained in the benchmark index against which it tracks performance, and is investing in short-term floating-rate notes and non-agency mortgage-backed securities, Schlanger said.
The Bank of America Merrill Lynch U.S. Broad Market index has plummeted 3.5 percent in May and June, the worst decline since a 3.9 percent dive in the two months ended October 2008 as the failure of Lehman Brothers Holdings Inc. ushered in the worst financial crisis since the Great Depression. Treasuries lost 3.3 percent in the last three months, for their third straight quarterly decline.
“Fixed income was there to provide stability and yield,” said Chris Acito, chief executive officer and chief investment officer of Gapstow Capital Partners, a New York-based alternative investment firm focused on credit with about $800 million under management. “Now both of those are gone.”
Record bond-fund redemptions in the month ended June 24 surpassed the previous high of $41.8 billion set in October 2008, according to TrimTabs in Sausalito, California.
In the most-recent period, investors pulled $52.8 billion from bond mutual funds, typically owned by individuals, and $8.9 billion from exchange-traded funds, or ETFs, which both institutional and private investors buy. Equity funds shrank by $2 billion, bringing their total reduction to $386 billion over the past six years.
Investors often retreat to money-market mutual funds during times of financial stress, accepting lower yields compared with bonds in exchange for higher liquidity. Assets surged during the credit crisis to a peak of $3.92 trillion in January 2009, according to data from the Investment Company Institute. Money funds held $2.59 trillion in the week ended June 26, data from the Washington-based trade group show.
Money-fund yields averaged 0.04 percent this year, based on the Crane 100 Money Fund Index, with the yield for the week ended June 26 at 0.03 percent. U.S. equity mutual funds had assets of $6.61 trillion as of April, according to the most recent ICI data. Bond fund assets were $3.56 trillion.
The benchmark 10-year Treasury yield rose 11 basis points, or 0.11 percentage point, to 2.04 percent on May 22 after Bernanke, in response to questions from Congress during testimony, indicated the central bank had given thought to reducing its stimulus at some point. The yield then rose 17 basis on June 19, the biggest move since 2011, to 2.35 percent, after the central bank chief said at a news conference in Washington “it would be appropriate to moderate the monthly pace of purchases later this year.”
Treasury yields soared as high as 2.61 percent on June 25, the highest level since August 2011, before declining to 2.47 percent as of 1:42 p.m. in New York.
With coupons this low, bond investors are seeing little return on their money. Real yields on 10-year Treasuries, after subtracting the annual inflation rate, are 1.08 percentage points, compared with the 6.4 percent aggregate earnings yield of U.S. stocks, according to Fed data compiled by Bloomberg. While the gap between inflation and 10-year yields is the most since March 2011, it is half the 2.2 percentage point average for the past 20 years.
An improving economy is dimming the lure of bonds as a haven. The Conference Board’s Consumer Confidence index rose to 81.4, exceeding all forecasts in a Bloomberg survey and the highest since January 2008, from a revised 74.3 in May, the New York-based private research group said June 25. Home prices have increased 12 percent since April 2012, according to the S&P/Case-Shiller Composite index.
The economy has added an average of 189,000 jobs each month through May, the fastest pace since 2005 when it created 207,000 positions per month, Labor Department data show. The unemployment rate fell to 7.6 percent in May, down from 8.1 percent in August. The rate for June may fall to 7.5 percent, according to the average estimate of 66 economists surveyed by Bloomberg.
“The labor market has continued to improve,” Bernanke said at his June 19 press conference. “Job gains, along with the strengthening housing market, have in turn contributed to increases in consumer confidence and supported household spending.”
Higher market rates triggered by Bernanke’s comments may hamper further improvements in the economy. The average rate for 30-year home loans has jumped to 4.46 percent as of June 27 from 3.40 percent on April 25, according to Freddie Mac.
“Rates going higher clearly will impact growth here,” Michael Lillard, the chief investment officer at the fixed income unit of Prudential Financial Inc. in Newark, New Jersey, said in a June 26 interview.
“Housing is one of your most sensitive sectors to interest rates and the mortgage rate has moved a lot, not just because of Treasuries but also because mortgage spreads have widened as well,” said Lillard, who helps manage more than $400 billion of bonds. “I think you begin to see it take some of the steam out of the housing rally.”
U.S. gross domestic product expanded at a revised 1.8 percent annualized rate from January through March, down from a prior estimate of 2.4 percent, the Commerce Department said June 26. The economy will grow 1.9 percent for 2013, according to the median forecast of 86 economists in a Bloomberg News survey in June, down from last year’s 2.2 percent increase.
Bond bulls see the higher rates as a buying opportunity.
“July will not be the same type of month” as June, Jeffrey Gundlach, chief investment officer of Los Angeles-based DoubleLine, said in a June 27 webcast for investors. “There are profits to be made in the bond market between now and the end of the year.”
Ten-year Treasury yields may fall by 25 basis points, Bill Gross, manager of the Pimco Total Return fund, the world’s biggest bond fund, said in a Bloomberg Radio interview with Tom Keene on June 27.
Yields and spreads over Treasuries were too low two months ago and “the Fed tilted over-risked investors to one side of an overloaded and over-levered boat,” Gross said in his monthly investment outlook posted on the Newport Beach, California-based firm’s website on June 27. “Stay calm and don’t panic.”
The bond market may receive support from financial institutions, which will need to buy as much as $5.7 trillion in safe assets including government bonds by 2020 to comply with the 2010 Dodd-Frank Act in the U.S. and capital standards set by the Bank for International Settlements in Basel, Switzerland, the Treasury Borrowing Advisory Committee said in a May 1 report.
The 14-member TBAC includes officials from Goldman Sachs Group Inc., JPMorgan Chase & Co., BlackRock and Pimco.
“What we are seeing right now is an overshoot,” said Ashish Shah, the head of global credit at AllianceBernstein Holding LP, which oversees $256 billion in fixed-income assets. “It takes time for institutions to make decisions.”
For BlackRock, the world’s largest asset manager with $3.7 trillion, “a reduction in the Fed’s asset purchases is not Armageddon -- it is actually healthy” because trillions of dollars of stimulus have failed to spur much credit growth and economic activity, a group led by Peter Fisher said in a mid-year outlook posted June 27 on the New York-based firm’s website.
Fisher, a senior managing director, joined BlackRock in 2004 after serving as undersecretary for domestic finance at the U.S. Treasury.
The market value of the Bank of America Merrill Lynch Global Broad Market index has contracted 3.8 percent since April 30 to $45.8 trillion. Global stocks fell 4.2 percent in the same period to $53.82 trillion.
Bernanke may have altered investors’ views about the Fed’s goals more than he expected with his comments in May indicating the central bank had given thought to reducing its stimulus at some point, said Martin Fridson, chief executive officer at New York-based FridsonVision LLC, a financial research firm.
“The events from May 22 have been more fundamental in nature and it’s changing people’s view,” Fridson, who started his career as a corporate debt trader in 1976, said in a June 25 telephone interview. “It’s not wise to conclude that everyone who’s going to leave has already left.”
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