How bond mar­ket up­heaval could af­fect all your in­vest­ments

Share prices grab the head­lines – but bond mar­kets are more pow­er­ful. And seis­mic forces are on the march. By Richard Evans

The Sunday Telegraph - Money & Business - - Front page - all

Stock mar­ket in­vestors ig­nore de­vel­op­ments in the bond mar­kets at their peril, es­pe­cially when, as now, once-in-a-gen­er­a­tion shifts are in the off­ing. Put sim­ply, the re­turn on cer­tain key bonds acts as a bench­mark for fi­nan­cial as­sets: shares, other types of bond, even prop­erty and cash in sav­ings ac­counts. “The sin­gle most im­por­tant driver of all in­vest­ment prices and re­turns is the yield on Amer­i­can gov­ern­ment bonds,” said James Clu­nie of Jupiter As­set Man­age­ment. “The big ele­phant in the room is what is go­ing to hap­pen to th­ese yields. There has been a 35-year bull mar­ket in bonds. If it is end­ing, it af­fects ev­ery­thing you do as an in­vestor.”

Sev­eral re­spected author­i­ties do in­deed think the bond mar­ket has turned a corner. We look at what has hap­pened and ex­plain why it could af­fect ev­ery as­set in your port­fo­lio.

Why is the bond mar­ket so im­por­tant?

If you can get a cer­tain re­turn of, say, 2pc a year on a gov­ern­ment bond, you will not lend your money to a com­pany via a cor­po­rate bond that also pays 2pc – it will need to pay, say, 2.5pc. Should the yield on the first bond rise to 3pc, you will de­mand 3.5pc from the sec­ond, and so on.

Bond yields and prices go in op­po­site di­rec­tions. If the yield on gov­ern­ment bonds rises, their prices fall; then, when in­vestors in­sist that cor­po­rate bonds con­tinue to yield more than gov­ern­ment bonds, their prices fall too.

This is the means by which price move­ments in one as­set are passed on to another.

Al­though there is more to shares than yield, enough peo­ple in­vest in them for the in­come for their prices to move if bond yields change sig­nif­i­cantly. The process is sim­i­lar to the one just de­scribed: many peo­ple cur­rently own shares be­cause the FTSE 100 in­dex yields al­most 4pc and 10-year Bri­tish gov­ern­ment bonds pay 1.3pc; some will sell and switch to bonds if the lat­ter start to yield 3pc in­stead, for ex­am­ple.

In essence, move­ments in the bond mar­ket tend to spread to other fi­nan­cial as­sets.

What has changed re­cently?

The Amer­i­can gov­ern­ment bond mar­ket ap­pears to have peaked af­ter the decades-long bull mar­ket. Looked at the other way, yields have started to re­cover: the yield on twoyear bonds re­cently reached 2pc, a level not seen since late 2008. It has risen by al­most three quar­ters of a per­cent­age point since Septem­ber. Strik­ingly, two-year bonds now yield more than the US stock mar­ket.

Louise Ya­mada, a re­spected Wall Street an­a­lyst, said the two-year US yield had been carv­ing out a saucer­shaped trough for al­most a decade.

“This yield is the ca­nary in the coal mine. It is le­git­i­mate to say that the bond bull mar­ket of the past 36 years is over,” she told The Daily Tele­graph last week. Bill Gross, a le­gendary bond in­vestor, said on Tues­day: “Bond bear mar­ket con­firmed to­day.”

Should I sell my bond hold­ings?

Ms Ya­mada ad­vised in­vestors to get out of all bonds with a du­ra­tion of more than two years. Any­thing longer will see an ero­sion of cap­i­tal value.

Bonds with short du­ra­tion are less risky: two years of slightly poor in­come rel­a­tive to that avail­able else­where is not a big prob­lem whereas 30 years of the same would be – and that dis­tinc­tion is re­flected in the price.

Mr Clu­nie has struc­tured the bond el­e­ment of his fund, via com­plex as­sets called de­riv­a­tives, so that it has “neg­a­tive du­ra­tion”.

“If bond prices fall, my fund should get a mod­est lift,” he said.

Should I sell my shares?

The dan­ger of such a dras­tic ap­proach, as Mr Clu­nie put it, is that “we never know what will hap­pen next”. Bonds could sta­bilise, or even re­cover.

In­stead, he is chang­ing the type of stocks in his port­fo­lio. “I’m sell­ing some of the ‘bond prox­ies’ [those seen as pay­ing re­li­able but rel­a­tively fixed div­i­dends] and buy­ing, for ex­am­ple, Bri­tish ‘value’ stocks,” he said. “The over­all ef­fect is that if the mar­ket falls, my fund will gain slightly.

“With stock mar­kets as high as they are and in­ter­est rates as low as they are, my mildly ‘short’ po­si­tions on both as­sets feel com­fort­able.”

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