Under the most likely scenario we will continue to be faced with a low-yield environment overall, with bond investors finding it increasingly difficult to exploit new opportunities to secure a return that is significantly in excess of current yields. But equally, it is hard to see why there would be a bear market in bonds anytime soon.
I always resist the argument that there is a bubble in bonds – the outperformance of the safer, more senior capital instrument is usually a sign of there being a complete absence of irrational exuberance.
Bonds may not offer great value in terms of the absolute total return or in terms of their real yields, but we do live in a world of low growth. Unless things change, the arguments for why yields will remain low are also applicable to why corporate earnings growth might be somewhat disappointing and thus why there is unlikely to be a massive asset allocation shift out of bonds into equities.
That is not to say equities can’t outperform core bond markets in the coming year – it would be disappointing if they didn’t given the level of yields and the support that is being provided to the financial markets by central banks – but it’s hard to see the growth environment being strong enough to see both interest rates and equities markets go up.
As an aside…25 years ago was the stock market crash of 1987.
I was a junior economist working for a financial research house that focussed on country risk and the immediate fear following the crash was that global growth would collapse, countries would default and the financial system would implode. Funny how things don’t really change.
Thankfully, we have so far avoided a financial disaster that would make October 1987 look like a mere blip (as it does on long-term charts of the stock market now) but the underlying fundamentals in Europe remain weak and scenes of protest against austerity on the streets of European capitals again this week highlight the political risk that is embedded in the current situation. The ECB has done a good job but risks remain.
There is a wonderful line in the charming movie, The Best Exotic Marigold Hotel, which goes: “Everything will be alright in the end, so if it is not alright yet, then it is not the end”.
If the economic outlook is not alright, then it is not the end the bond bull market.
