“My grief lies onward, and my joy behind” sounds rather like something from a Shakespearean sonnet. That’s because it is.
Reading it made me think of the Great Rotation and the mistaken belief that the 30-year bull market in bonds was about to come to an abrupt end. That was never going to be the case, and more people are starting to realize that now. As we entered 2014, though, the end was a very real concern, supported largely by the assumption that the U.S. and the U.K. were about to embark upon a rate-rising path.
Although apparently imminent, that path hasn’t yet been taken on either side of the Atlantic. And expectations keep getting pushed back. The strength of the U.S. dollar has complicated things. In a world starved of income, any kind of yield is sought. But one backed by the strength and credibility of the U.S. Treasury is particularly attractive. The European Central Bank’s actions have exacerbated the situation.
The Great Rotation argument was flawed for the simple reason that it ignored the weight of bonds’ structural, inherent demand. People need income, and bonds will continue to play the starring role in providing it. Unlike equities, the income level from bonds is effectively fixed at the outset. At the institutional level, this simple fact also offers huge appeal. Matching liabilities — of which there are still vast quantities sloshing about — is big business. There are two sides to every market, and even a modest rise in yields is likely to propel a plethora of eager buyers into action.
Yields are negative in multiple European markets. This state of affairs applies not only to government bonds but now to some corporate bonds as well. The zero bound has therefore been broken, proving that it is just that — a mere boundary, as opposed to an impenetrable threshold.
It takes a certain kind of optimist to see the positives in the guarantee. Yet it is a guarantee of loss; that is what negative yields mean in practice. You get back less than you put in. Put another way: You effectively pay to lend money out.
There is another potential positive for investors, though: The notion that just because yields have gone negative doesn’t mean they can’t fall farther. Banks, insurance companies and pension funds all have to adhere to rules that force them to buy assets of a certain quality. This pushes them toward bonds, regardless of how expensive they may appear. Then, traders and speculators seek to take advantage of the subsequent short-term opportunities, which can add to the downward pressure if that is where most market observers see the wind blowing.
All of this serves to highlight the strangeness of the world we now live in. Daily usage of words like “unprecedented” and “exceptional” renders them almost meaningless. In this case, however, they ring true. Corporate bond yields turning negative truly is unprecedented.
In such an uncertain environment, being nimble, and therefore able to quickly shift portfolio positioning, is crucial. Removing home-bias tendencies is imperative, too. The ability to alter geography and credit quality can, if implemented effectively, offset the effects of rising rates domestically.
And so, although Shakespeare’s sonnet may miss the mark with bond investors at present, to be fair to him, he didn’t have us in mind when he wrote his haunting words. We could, however, still learn something from the Great Bard. His ability to break away from literary traditions and go against the grain should inspire us to have convictions in our views and take positions that may contradict conventional wisdom.
We need to recognize that what worked in the past will not necessarily work in the future.
Brad Crombie is global head of fixed income at Aberdeen Asset Management in London.
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