Advisors and investors beware, the long-swelling bubble in the bond market looks set to pop. Major bond investors are as worried as they have ever been, mostly because of the reduction in easing that is finally coming to markets. Central banks are letting off the gas pedal for the first time in almost a decade, which could have a devastating effect on the bond market. According to the head of fixed income at JP Morgan Asset Management, who oversees almost half a trillion in AUM, “The next 18 months are going to be incredibly challenging. I am not an equity investor, but I can just imagine how equity investors felt in 1999, during the dotcom bubble”. He continued, “Right now, central banks are printing money at a rate of around $1.5tn per year. That is a lot of money going into bonds. By this time next year, we think this will turn negative”.
FINSUM: There is a lot at stake in bond markets after years of relentless gains on the back of dropping rates. JP Morgan seems to be very wary.
It feels like years that we have been writing about the forthcoming “great rotation” in markets, or the big move out of fixed income and into equities. It has many times been predicted, and generally fallen far short of expectations. However, it may be about to occur, says Bloomberg. For the first time in a long while the risk-adjusted return on stocks has been outperforming bonds, a key factor in how the market might turn. “Flows do follow performance, and we know U.S. retail investors are less valuation-sensitive than smart-money investors … The increase in total returns from stocks, if it continues over the next couple of quarters, raises the prospect of a tipping point in asset allocation in favor of equities”, summarizes an equities analyst at Credit Suisse.
FINSUM: Perhaps a great rotation has not fully happened, but US average allocation to equities is near a long-term high, so it is not as if people have been holding back. We are still skeptical allocations are going to change much from here unless the Fed gets really active with hikes.
The Wall Street Journal has published an article arguing that many investors are wary of the bond market purely because of misunderstandings. This may also be the reason that many lose money in the market. One of the key elements that seem to be poorly understood is that fact that the bond market is not unified in the way stocks are. It is composed of hugely variant types of bonds, all with their own pricing, so views such as “the bond market is overpriced” are too generalized to be relevant. Additionally, many seem to forget that one of the primary purposes of bonds in a portfolio is to hedge against stock losses.
FINSUM: It seems there is still a lot of room for human advisors to educate clients about the opportunities and risks in the bond market. This seems especially true at a time when stocks are doing so well.