With 10-year gilts and treasuries only paying in the region of 1.75%, a natural question is how much lower can they go? However, Choukeir warns that a bond bubble remains a real possibility, pointing to the Japanese example, where 10-year yields fell from 8% in 1990 to 1.75% in 1997, while they currently offer 0.78%.
Despite this, he believes government bonds continue to experience positive momentum, with central banks remaining as the marginal buyers.
“Most people seem convinced the bond market is in a bubble,” he says.
“Such negative sentiment suggests an overly bearish view on the asset class. We like to use sentiment as a contrarian indicator, so we view such pessimism as an opportunity. In 2011, most investors had a negative bubble view on bonds – that sentiment was wrong. Yields dropped from nearly 3.5% to close to 1.75% currently.”
The economic environment, he suggests, favours bonds with weak growth, combined with benign inflation, keeping central bank taps flowing, thereby propping up bond demand and suppressing yields.
“While bonds present some risks, it is important to note how they behave in extreme market conditions,” he adds.
“Our research shows that during the 15 worst performing quarters for equities since 1871 (therefore including the big bond bear market from 1950 to 1981 and the big bond bull market from 1981 to today), government bonds preserved wealth or rose 14 times. Therefore, at the extremes, bonds diversify equity risk – even during bond bear markets.”
“On balance, although stretched valuations make holding government bonds less attractive, other parameters we consider crucial continue to support the view to hold bonds.”
An interview with Choukeir, and an in-depth look at his portfolios and views on different asset classes features in the November edition of Portfolio Adviser, out now.
