6/24/2013 5:30 PM ET|
Lost decade for bonds looms
US Treasurys are providing less than half the yield of stocks, giving investors little reason to keep the bull market in bonds alive.
U.S. Treasurys 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 Treasurys yield 2.61%, up from a 2013 low of 1.61% on May 1, the aggregate earnings yield of stocks in the Standard & Poor's 500 Index was 6.4% of the index's price level, according to Federal Reserve data compiled by Bloomberg. 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 to BlackRock are avoiding longer-term Treasurys, 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 Gamco Investors, 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 $9.1 billion from fixed-income mutual funds and exchange-traded funds in the week ended June 5, the second-highest total in more than 20 years, according to Lipper.
JPMorgan Chase, the most-active underwriter of corporate bonds since 2007, earlier this month joined Barclays, Bank of America., Morgan Stanley and Goldman Sachs in recommending stocks over most bonds as equity returns outpace company debt by the most since at least 1997.
The Bank of America Merrill Lynch U.S. Corporate & High Yield Index's 2.6% loss this year compares with a 12.8% gain for the S&P 500 Index ($INX), including reinvested dividends. Treasurys have lost 2.8%, according to the Bloomberg U.S. Treasury Bond Index.
Fed Chairman Ben 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 on Bloomberg Television. "When the game starts to change with central banks, it is inevitable bonds are going to suffer."
The recent bond selloff wasn't limited to the United States. Yields on 10-year German bunds soared 21 basis points last week to 1.73%. U.K gilts increased 34 basis points to 2.4%.
"Liquidity today is king and what we're getting is cascading liquidity failures," Mohamed El-Erian, chief executive and co-chief investment officer at Pimco, said. "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% 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%.
Prospects for less Fed stimulus also hit stocks last week. The S&P 500 fell 2.1% to 1,592.43, down from the record high of 1,687.18 on May 22. The benchmark Stoxx Europe 600 Index 3.7% , while the MSCI World Index (MSCI) dropped 2.9%. The S&P dropped 1.21% Monday.
Profits for companies in the S&P 500 will jump more than 10% in each of the next two years after almost doubling since 2008, the average of more than 11,000 analyst estimates. Earnings gains of that magnitude would send yields to 8.3% 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 hedge fund Omega Advisors, with $8.4 billion under management, said in an interview on Bloomberg Television. "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. Treasurys 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% in the 12 months ending of June 21, beating 91% of its peers. It has lost 0.1% this year, better than 88% 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 Treasurys if rates rise than many other asset classes."
Slow inflation is also a lure to Treasurys. The Fed's preferred gauge of consumer prices, the personal consumption expenditure index, will average 0.8% to 1.2% this year and climb 1.4% to 2% in 2014, the central bank reported June 19. Its target is 2%.
Fed economists revised their forecasts for U.S. economic growth, saying that gross domestic product will rise 2.3% to 2.6% this year, compared with a previous estimate of 2.3% to 2.8%. The rate next year might be as high as 3.5%. Unemployment will drop to as low as 6.5% 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% on June 21, the highest since March 2011, after falling to negative levels as recently as March.
"Those that are selling Treasurys 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. Gross has been advising investors to buy Treasurys 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% of its holdings in Treasurys in May, down from April's 39%, 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% in 2013, beating just 12% of competitors.
"Real growth to lower unemployment below 7% 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 in Westport, Connecticut, said in a telephone interview. "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 Treasurys, particularly on the longer end of the curve," Rick Rieder, chief investment officer for fundamental fixed-income at BlackRock, said. "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% 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% if they reached 3% at the end of 2014, Bloomberg data show. Rates on the benchmark securities touched a record low of 1.379% in July.
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.
"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 in Toronto, said. "The odds of that happening at least in the next year have come down significantly. The economy has managed to crawl through."
Treasuries yields are still below the average 3.57% 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."
More from Bloomberg
VIDEO ON MSN MONEY
Urging people to dump bonds and buy stocks?
Calling all sheople, calling all sheople!
Plunge on in with that advice, and good luck.
After all, what the big investment houses advise must be in your best interest, right?
Oh, and don't forget to hold your breath.
It is understandable to see investors voice their concerns about a lost decade in bonds. However, I am amazed at how unconcern these same investors are with the potential of losing a generation of degreed young Americans. These young Americans who graduated from college between 2007 - 2013, are faced with taking low wage jobs that they had during their teen years and fault to even get those, as adult aged Mexican immigrants held the majority of these jobs. These students (young Americans) went onto college, using student loans, their parents retirement savings and holding down jobs to complete a college degree. Completing a college degree is not easy with well over 50% of students who enter college not graduating at all. What do these students get in return for there investment in themselves, they get told by CEO's that they are useless, that there is no way any of these corporations can use them. The corporations refuse to conduct on the job training, for which most of the CEO's received as they did not major in the Science or Computer Programming etc... This is the first time I believe this type of trashing of human capital has occurred in American history. It is led by CEO's who have no allegiance to the U.S.A. Frankly, they do not care about the American citizen or our proud history of each generation doing better than their parents.
Here is a novel idea, how about taking some of that money you all have overseas and developing an on the job training program. Bring in degreed college grads (2007-2013) non technical, run them through a training program, select at a minimum of 10 to hire and allow the others to rotate onto another companies program. These non hires would be able to leverage what they have learn and possibly increase their chance of landing a permanent position on down the road. The benefit for the corporation is a tax credit (you name the amount CEO's for each hire) but you don't get the credit if you do not hire at least 5.
The country needs this and the degreed students in this generation would really appreciate your investment. Please do not continue to let our young degreed human capital go to waste.
CEO's, Congress and President, please do your jobs and work together.
ATC: "Uh, Helicopter Ben we have you in sight"
H-Ben: Approaching Glide slope, i have a heavy load here"
ATC: 'Understood, ready for your -700 point reversal injection"
H-Ben: "Opening bay doors, prepare for fiat money dump"
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