Strong economic growth, tight labour markets, rocketing oil prices and heady asset price inflation h...
Strong economic growth, tight labour markets, rocketing oil prices and heady asset price inflation have combined to form a corrosive cocktail for global bonds in 1999.
Sentiment has swung dramatically from the overwhelming bullishness prevailing in 1998. In early October 1998, the benchmark US 30 year bond yielded just 4.7%; a year later, that yield has risen two percentage points and the price of the bond has fallen almost 25%.
That compares closely with the damage inflicted by the 1994 bear market, when the price of the long bond fell 26% from the 1993 peak.
These losses suggest however, an awful lot of the "bad news" (from a bond perspective) on growth and inflation has been taken on board.
Indeed, bond investors could be forgiven for fearing they are saddled with an outmoded asset class. That 25% price drop on the US long bond is in stark contrast to the 150% or so gains on the Nasdaq over the same period and technology stocks are now perceived to be the only game in town.
With the Fed still judged to be in tightening mode and the spectre of inflation haunting markets, why should anyone consider investing in quality bonds again?
As experienced investors we know the consensus often gets it wrong. Sadly, when we all agree on something, it's probably already largely discounted and we should focus instead on what might surprise and cause a reassessment.
With hindsight, just as deflationary fears reached panic proportions, we should all have been selling bonds and wondering where the growth surprises might appear.
The almost universal and completely mistaken bullish view on the euro at its launch is another example of how investors should challenge conventional wisdom.
These examples demonstrate what huge opportunities can lie in taking a contrarian stance. Right now, big surprises would be Millennium Bug problems (having worried about this earlier, the market now seems strangely sanguine), any upset in equity markets and any weakness in the US or global economy.
Any or all of these developments could trigger a strong rally in government bonds.
Of course, just because events are not priced in doesn't mean investors should automatically position their portfolios to benefit on the possibility that they might happen.
It certainly does not always pay to be a contrarian, indeed the very precondition of an extreme in market sentiment means that such opportunities are infrequent. However, right now the risk/reward balance favours taking a more constructive stance towards government bonds.
Even if the worries that have beset the bond markets prevail a while longer, bonds are still more likely to range trade than to suffer further dramatic losses. The markets are already fearing inflation and further strong economic growth will not have the same devastating impact on bond yields as it did when these fears first struck.
Meanwhile, many investors seem to have completely ignored the theme of structural deflationary forces that drove bond yields down in 1998, despite huge advances in technology that are clearly deflationary.
Salaries of IT experts have been inflated but the transparent pricing of goods available on the internet means higher wage costs cannot be passed on.
This year, talk of a "new paradigm" has been deemed "old hat" but there is no evidence yet to indicate it is time to go back to the old models.
At this stage, bonds discount much fear about something that has not yet happened and very little greed. Investors who were bearish on the euro back in January are starting to look at bonds again.
Helena Morrissey is fund manager at Newton Investment Management
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