Taxi test for bonds signals end of the ‘Tina’ era

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The classic way to judge when stocks are having a bubbly moment is the taxi test. When drivers start telling you about their online portfolio or asking whether to buy shares in Tesla, you know stock markets have burst into the public consciousness.

Something similar now is going on with bonds. At a dinner this week, a specialist in bond investment told me that for the first time in his lengthy career, he’s in demand from his colleagues in equities, who are finding excuses to oh-so-casually swing by his desk to ask how to go about buying some government debt for their personal savings.

This is highly unusual. Equity investors generally listen to their counterparts in the bond markets like the kids in the Charlie Brown cartoons listening to grown-ups talking. It’s all just white noise.

Perfectly reasonably, they have spent the past few years wondering what those weirdos in the bond market have been up to. Why would you buy stuff with a negative yield, so you know you’ll take a loss on it if you hold to maturity? All Team Bonds can say now is that it made sense at the time — strange things happened in the zero interest rates era.

Now, though, bonds are back with a vengeance. Central banks have dragged rates up from close to or even below zero at a blistering pace in an effort to tame the outbreak of post-pandemic inflation. And they are not done, as the surprisingly muscular rate rise from the Bank of England demonstrated this week. All of a sudden, bonds yield something. Quite a lot, in fact — 5 per cent on a two-year UK government bond, for example, or 3.7 per cent on a 10-year US Treasury.

The difference between the taxi driver test and the “sharp suits from equities who have been laughing at the bond nerds for years” test is that nobody, or at least nobody I have yet been able to find, thinks bonds are going to pop. 

One important caveat: yields could very easily push higher from here, leaving new buyers with a paper loss. Many buyers have already faced this test. But anyone willing to buy bonds issued by safe governments and even companies — and to hold them to maturity — is locking in the best yields in a generation. And if something horrible happens to geopolitics or the global economy then, all things being equal, government bonds would jump in price.

“Exiting the zero bound is the single best global market development we have seen in 20 years,” said Joe Davis, global head of the investment strategy group at investment juggernaut Vanguard.

It finally opens up an alternative to equities and stops investors from having to venture into uncomfortably risky territory in search of decent returns. Even US money market funds — pots of easy-access cash parked in safe debt instruments — offer a yield of about 5 per cent. “It’s good to have the interest of all investors,” said Davis. “Before, it was only the equity market.”

The latest data on fund flows from Morningstar underlines this point. It notes that in May, fixed-income funds were, in its words, “showered” with money — more than €12bn in net inflows in Europe, forging the seventh positive month in a row. Equity funds, meanwhile, dropped €1bn, the biggest amount since October last year. 

Over in the US, the story is the same but of course much bigger. Equity funds shed about $27bn in May — again, the seventh consecutive month of outflows. Meanwhile, taxable-bond funds raked in $18bn, taking the total so far this year to almost $113bn.

It is not hard to see why. Even the highest-rated US corporate debt yields about 4.6 per cent, according to a widely watched Ice/Bank of America index.

Christian Hantel, a senior portfolio manager at Vontobel in Zurich, said he had expected the “euphoria” in demand for bonds and bond funds to calm down in the spring, especially given the short, sharp banking crisis that erupted on both sides of the Atlantic. Instead, he said, it is picking up again as investors try to lock in yields, especially when they weigh up the risks of instead bulking up in expensive-looking equities.

“A lot of people have missed the rally in equities and they don’t want to go back into the game now,” he said.

The main thing that can go wrong from here is a truly ugly, punishing recession, especially assuming that central banks are too stubborn to trim interest rates in response. In a worst-case scenario, that could be enough to kick off a meaningful wave of debt defaults at the riskier end of the market.

But César Pérez Ruiz, chief investment officer at Pictet, is now going back to clients who said “no thanks” to bonds at the end of last year with a whole new proposition.

“I am saying to them now, ‘Are you sure you want 50 per cent equities?’,” he said. “Maybe people might like 30 per cent and then top up the rest with investment-grade debt so you get equity-like returns with lower volatility. Just buy [bonds from] good companies, enjoy, let them mature.”

The era of Tina — based on the mantra that There Is No Alternative to equities while bonds deliver zero yields — is well and truly over. Stocks need to fight for their place in a mixed portfolio.

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