At face value there is a lot still going for local bonds

Bond analysts are sharply divided over the future prospects of the market, but on a balance of probabilities domestic bonds may surprise on the upside as foreigners continue to seek yield, political risk notwithstanding.

Domestic bonds have been the best-performing asset class for the first nine months of 2016, growing 15.5%. The property index delivered 8.82% growth and cash yielded 5.42%. Equities firmed 4.82%.

The R207 has been the market favourite, strengthening 13.2% so far in 2016 as yields fell on rising prices. The R186 has gained 10.1%. Local yields continue to outshine those of global developed markets.

The yield of 1.009% on the UK 10-year gilt, and 1.76% on the US benchmark 10-year treasury bond pales in comparison to the 8.76% yield on the R186 and 8.05% on the R207.

Taken at face value, there is a lot favouring domestic bonds. What then is holding yields back from strengthening further?

The main reason cited by analysts is political risk, as well as a potential sovereign downgrade by ratings agencies at the end of the year.

The potential for a domestic bond rout is illustrated by the sharp repricing in credit default swap rates (CDS) following the fraud charges levelled by the Hawks against Finance Minister Pravin Gordhan on October 11.

Last week the five-year CDS spread — the cost of a sovereign default as rated by investors — climbed more than 260 points, surpassing that of Turkey and Russia, and in line with Brazil’s five-year CDS spread.

What that means is that domestic bonds are already regarded as trading at default levels. Higher bond yields and credit spreads were likely to add upside pressure to government debt service costs, as well as limit foreign investment into local bonds due to risk aversion, analysts at Nedbank Corporate and Investment Banking say.

“Bonds are no longer the safe haven risk-free asset class of the past,” says Citadel investment strategist Maarten Ackerman. He suggests that investors switch out of bonds and into equities, preferably high-dividend yield companies. It is far better to own a company’s stock than to be invested in bonds, he says.

Negative interest rate bonds mean the investor in bonds receives no interest from the issuer. Globally $11.9-trillion is invested in negative yielding global bonds, presenting possible dire consequences for investment vehicles, such as pension funds. Funds now have to adjust expected future returns to lower levels in a deflationary environment.

What worries Futuregrowth Asset Management’s bond portfolio manager Wikus Furstenberg is that nonresidents have stampeded into local bonds, with inflows now at 2012 levels. While foreign capital inflows were welcome, there is a caveat. Foreign portfolio flows can be fickle and an orderly exit is never guaranteed, he says.

Coronation fixed-income analyst Nishan Maharaj says the near-term prospects for bond yields will depend on two factors: the sustainability of low global yields and the strength of the local economy.The domestic political landscape is failing to assist an ailing economy. “But our bonds currently look very attractive relative to those in developed markets,” he says.

Further volatility in the bond market is assured as these forces play themselves out. Old Mutual Multi-Managers investment strategist Dave Mohr remains positive, saying valuations still favour local bonds. “We are overweight fixed income in our strategies.”

SA inflation is expected to decline in 2017 and the repo rate

THERE REMAINS ANOTHER IMPORTANT BUMP IN THE ROAD. SA COULD LOSE ITS PLACE IN CITI’S WORLD INDEX