Bond bull market is over

[GoSeigen]

Noting your post is about Gov't bonds/Gilts, may I ask, how does this philosophy apply to corporate bonds, such as NCYF, BIPS, etc?

My thinking is that their prices will be subdued (fall) whilst interest rates are high/rising, but once there are signs of reducing interest rates, demand will push up their SP's and the dividend yields fall. Currently NCYF offers a yield of c 9.75%.

Hmm I'm not familiar with either NCYF or BIPS, thy both appear to be shares (maybe of a fund) not bonds.

Assuming that they are corp bond funds, and especially if they are longer duration, their yields (hence price) will not necessarily track interest rates. Longer dated corporate bonds are subject to a range of other considerations, e.g. inflation expectations, credit spreads. The lower quality the bonds or the longer dated the more closely they will follow equity markets. So they could easily be crashing when interest rates are falling. Bonds that most closely follow interest rate movements are (of course) shorter dated gilts.

Just eyeballing the respective charts neither looks very pretty for the near future, but I don't have a crystal ball...


GS

[dealtn]

And with the yield curve positive right out to 38 years this week for linkers, what’s not to like about a positive real return for nothing like equity-like risk?

The fact that that real return is still tiny, albeit finally positive, and doesn't reflect the risk.

[Lootman]

And with the yield curve positive right out to 38 years this week for linkers, what’s not to like about a positive real return for nothing like equity-like risk?

The fact that that real return is still tiny, albeit finally positive, and doesn't reflect the risk.

And it is an exposure to sterling, and it carries the opportunity cost of not being in equities, that historically gives better returns.

[richfool]

A topical article ftom Trustnet. The second part more relevant to bonds:-

Bonds and cash on top in July as investors shun equities

in July, less than half the inflows of the previous month, although there was strong buying towards the end of the month, the report noted.

Oft-forgotten money market funds also were added to last month. In total investors added £403m of net money to the sector.

Glyn said: “The return on a bond can be predicted with near certainty if it is held to maturity, depending on its credit rating, while equity markets are fraught with risk. With the outlook for global economic growth uncertain and corporate earnings estimates being revised down, attractive fixed income yields have tipped the balance for fund investors away from equities for the time being.

“Meanwhile, money market funds offer even higher short-term returns while policy rates are still climbing and their low risk means capital values remain very stable should investors wish to switch back to higher-risk assets in future.”

However, he reminded savers that inflation remains higher than bond yields in many parts of the world, particularly the UK, meaning returns are still negative in real terms.

“But if and when inflation returns to target, locking in at today’s high bond yields for the medium to long term will offer significant benefits to those investors who have committed capital to fixed income funds,” he finished.

https://www.trustnet.com/news/13386231/ ... n-equities

[GoSeigen]

A topical article ftom Trustnet. The second part more relevant to bonds:-

Bonds and cash on top in July as investors shun equities

in July, less than half the inflows of the previous month, although there was strong buying towards the end of the month, the report noted.

https://www.trustnet.com/news/13386231/ ... n-equities

Thanks richfool.

Very interesting the extent of the consensus rejection of the OP. Like everyone (private investors) thinks gilts are the best asset to be buying right now. It's the complement of the utter rejection of gilts in 2006/7 when it was one of the best times ever to buy them. And it reminds me of the call in Aug 2008 by one BertEEE that it was a wonderful time to buy banks on a five-year view -- not for the consensus of that view so much as the anchoring and timing: banks were much cheaper than a year prior, and obviously a better buy than right at the top, but that was poor consolation for people who bought in Aug 2008 and are maybe just breaking even around now (guessing).

For me, I don't see the attraction of gilts yet. People talk about index-linked gilts, but their real yield is something like 1%! That's the best you'll ever manage if you hold to maturity. And if you don't you're an evil "trader" LOL. If inflation returns to the MPC's target of 2% it means you'll get no more than 3%. In any case, my investment target is 3% net of inflation, costs and tax (is that a ridiculous goal these days!!??), so obviously for me ILGs are still out of the question. Clearly people look around and they think hmmm, I've had almost no return from my shares for 23 years, property the same for 15 years, while gilts have had negative real yields and now they have a positive real yield! Woo, I'd better buy some gilts.

I'm not flat out against gilts. For the "I'm saving" people who are happy just getting cash-like returns from their gilts I'd say a small amount of short-dated gilts, either conventional or IL is fine. It's not going to be worse than shares since 2000 anyway! For longer dates, the curve is inverted, I don't like that. Also with yields up above 4% and likely to stay there IMO convexity will no longer turbo boost returns like in the 2010s. However, my marginal rate of borrowing is now 14% vs 9% (or 40% vs 18% for overdraft) compared to a year or two ago. So for me much better to keep fully invested in equities and throw any spare cash at debt (much of it financed at sub-2% a couple of years back) and living costs.

It's an interesting situation, like I say the consensus is fascinating, I'll very much enjoy sitting on the sidelines and watching and will certainly come back and eat humble pie if I turn out to have read this completely wrong.


GS

[Jwdool]

I'm not convinced by the negativity on gilts. There are a number of reasons why buying long dated gilts today makes a lot of sense. The most important of those reasons is the temporary nature of current inflation. There are clearly three major causes of the inflation spike we've seen over the last year. Covid supply shock, Russia/ Ukraine energy shock and QE/ fiscal stimulus (furlough etc.). None of those three factors are likely to have lasting effects beyond 24 months although we are looking at the inflation effects being extended due to second round effects (wage demands etc - also not likely to last beyond 24 months).

On this basis, we could quite easily see inflation returning to or below 2% target within 12-24 months. On top of that, we've seen interest rates rising from virtually zero to 5.25% - with the effects of that tightening only just starting to take effect. Deflation on the supply side is already feeding through to PPI - globally and we can expect a sharp fall in energy and food prices in the UK over the next 6 months.

Once that data hits the CPI figures (which is already has), we could see long dated gilts returning to 2.5%-3.5% rates - hence presenting a great opportunity to secure >5% on the short end and ~4.6% on the long end.

The other major reason to favour gilts is the credit risk (i.e. zero). Investors have been presented with a series of financial credit events (SVB/ Signature etc) as well as catastrophe risk (covid/ nuclear Russia etc). Gilts provide protection against market panic in a way that no other asset can do. They allow investors to sleep at night without worrying about the solvency of the issuer.

Finally, gilts (as well as other QCBs) offer a tax free capital gain - unlike equities or other instruments. Given there are issues such as the 2061 0.5% note trading in the 20s, that is a phenomenal opportunity to enjoy tax free gains over a significant part of an investors lifetime.

Of course there is the risk that inflation remains at or above target - but I've not seen any developed government/ central bank display anything other than unanimous consensus to drive out inflation. For me, that is the only risk to gilts on a risk adjusted basis - but it is one that I think they will resolve. Long term inflation is likely to be low (aging population/ AI/ technology) going forward so gilts look like a great buy at these levels.

[Wuffle]

You aren't supposed to KNOW, that's the point.
Welcome back to the world of the 60/40 portfolio.
Which you bought ecause you didn't know, not because both bits were going up.
Tax positions notwithstanding.

W.

[NotSure]

Couple of comments. Gilts are not the only bonds. Also, folk are not necessarily going all in, simply allocating a percentage to the wider bond world as you can finally lock in what may well become a positive real yield for a portion of your portfolio in what are very uncertain times. I'm still 70% global equites, so hardly rejecting them, but in my annual pension realignment, I did allocate more to global, corporate and governmental bonds than I have of late (or ever, really). Only a small fraction of the remaining 30% is gilts. But I've hardly become a bond fanatic, far from it. I'm also not trying to maximize gains, just trying to achieve a little real growth (better than cash) without putting my entire pension more peril than necessary.

I confess that in my non-pension investments, I even have some cash these days! But if someone can kindly point me at an alternative asset that will definitely be up 5 or 6% in nominal terms by this time next year, I'd switch in a flash

[GeoffF100]

And it is an exposure to sterling, and it carries the opportunity cost of not being in equities, that historically gives better returns.

Index linked gilts match a UK spending liability in the future. Sterling exposure is irrelevant. If the pound falls, prices rise, but you are protected against that.

Equities historically GAVE better returns (eventually) in the markets that they did. History is in the past.

The markets believe that index linked gilts and equities are equally desirable at their current prices, but some market participants are more risk averse than others. Some can stand a big loss. Others cannot. Some can wait decades for their investment to turn good. Others cannot.

[NotSure]

I should add that of course duration is very important. Long bonds have the potential for capital gain and loss and are a very different beast to shorter ones (I am at the shorter end). I don't think you can just says bonds/gilts good/bad without going into the subtleties.

[mc2fool]

For me, I don't see the attraction of gilts yet. People talk about index-linked gilts, but their real yield is something like 1%! That's the best you'll ever manage if you hold to maturity. And if you don't you're an evil "trader" LOL. If inflation returns to the MPC's target of 2% it means you'll get no more than 3%. In any case, my investment target is 3% net of inflation, costs and tax (is that a ridiculous goal these days!!??), so obviously for me ILGs are still out of the question. Clearly people look around and they think hmmm, I've had almost no return from my shares for 23 years, property the same for 15 years, while gilts have had negative real yields and now they have a positive real yield! Woo, I'd better buy some gilts.

I'm not flat out against gilts. For the "I'm saving" people who are happy just getting cash-like returns from their gilts I'd say a small amount of short-dated gilts, either conventional or IL is fine.

LOL! Nobody said gilt traders are evil!

People have different goals, and indeed different targets for different parts of their allocations, with typically higher targets for the riskier parts and lower targets for the safer parts. For me capital preservation is more important than trying to grow the pot, so any real yield of over zero is more than OK for that part.

"Cash like" returns have been negative in real terms for many yonks. If inflation returns to 2% what will interest rates do and will bank/b.soc. savings rates return to less than 2%? I dunno, we'll have to wait and see, but in the interim index linked gilts offer a better alternative.

[GoSeigen]

Couple of comments. Gilts are not the only bonds.

To be clear, bonds in the context of the OP are US government bonds and notes and other developed country gilt-edged securities.

The bond bull market is over you say! I guess that explains why bond funds, especially longer duration ones, are down 30 or 40% from their peaks over the last year or two? I.e. a very firmly established bear market.

Sarcasm clear without the smiley! But in case anyone hasn't noticed the end of the [secular] bond bull market has been called many many times, often after "30% or 40%" falls and each time proved incorrect. This time I think it is clear: the yield trend was decisively broken last year, there has been a higher high and for proper confirmation of the new regime there needs to be a higher low, but I am willing to bet big that yields do not drop below COVID levels again.

Of interest to me is whether the bear market is over

I'm saying in this thread that the bear market will last a generation. That means a headwind for bonds the majority of the time.

I think it should be stressed that the secular bull market in bonds is now well and truly over and from here on there will be headwinds for bonds. It would be a very good idea for people to have a little think about the meaning of fixed interest, especially if they were not invested in gilts for large parts of the gilt bull market.

They are either good or bad going forward. It is irrelevant what people were invested in historically.

I think MrFoolish missed the point, which was about investors' judgement, and that DOES matter because the price at which you buy an asset is fundamental to the return you'll derive going forward. So actually it's 100% relevant. [If you argued (say) in 2014 that gilt yields could not possibly fall another 100bp but they did -- and more -- then shouldn't you ask whether you missed something about gilts that could cause a similar misjudgement?]

A nice broad overview of bonds ought not ignore inflation linked bonds, especially if the gun is being pointed mostly at government bonds. Linkers love inflation. And with the yield curve positive right out to 38 years this week for linkers, what’s not to like about a positive real return for nothing like equity-like risk?

I've touched on this already. Will just add that risk is what investing is about. I want to invest in stuff when the consensus believes that it carries maximum risk, and avoid assets that the consensus views as "safe".

I hadn’t looked at Gilts for donkey’s years before Liz and Kwarti made them interesting again.

If anyone thinks that what is driving gilts and bonds is a Truss/Kwarteng think they are sorely mistaken.

The downgrading of the USA credit rating is perhaps a wake up call for UK Gilt investors.
Might the same thing happen to us?

Might be on to something there...

Almost by definition the bond bull market was over once base interest rate hit near zero.

People called the end of the bond bull many times before that.

You aren't supposed to KNOW, that's the point.

Sorry, don't subscribe to that defeatist point of view. See comments above about price, consensus and human judgement. I certainly don't deprecate the 60/40 idea though...

The markets believe that index linked gilts and equities are equally desirable at their current prices,

By definition you mean? Is the market ever wrong in its judgement of desirability?



GS

[dealtn]

Once that data hits the CPI figures (which is already has), we could see long dated gilts returning to 2.5%-3.5% rates - hence presenting a great opportunity to secure >5% on the short end and ~4.6% on the long end.

It could. It could be a lot worse. In which case you want an appropriate return for running that risk.

So lets assume inflation drops back to the target of 2% in say 2 years time, certainly not impossible. Under that scenario you appear to feel a long dated gilt yield of 2.5% to 3.5% is appropriate. (That would normally look too low to me, but whatever). So what is the current 2 year forward implied yield for long dated Gilts currently?

[MrFoolish]

The markets believe that index linked gilts and equities are equally desirable at their current prices,

By definition you mean? Is the market ever wrong in its judgement of desirability?

GS

Of course it is sometimes wrong. Everyone is sometimes wrong, and that will include you. (Donald Trump is never wrong... or so he says.)

[GeoffF100]

[

The markets believe that index linked gilts and equities are equally desirable at their current prices,

By definition you mean? Is the market ever wrong in its judgement of desirability?

Yes, pretty much by definition. No, it is their money. They do not know the future, but neither does anyone else.

[Jwdool]

Jwdool wrote:
Once that data hits the CPI figures (which is already has), we could see long dated gilts returning to 2.5%-3.5% rates - hence presenting a great opportunity to secure >5% on the short end and ~4.6% on the long end.



It could. It could be a lot worse. In which case you want an appropriate return for running that risk.

So lets assume inflation drops back to the target of 2% in say 2 years time, certainly not impossible. Under that scenario you appear to feel a long dated gilt yield of 2.5% to 3.5% is appropriate. (That would normally look too low to me, but whatever). So what is the current 2 year forward implied yield for long dated yields currently?

If, as I think is likely, inflation falls back to 2% within 2 years (if not a lot sooner), then the purchase of low coupon, long dated gilts will perform very well. I'd expect to see e.g. the 0.5% 2061 series climbing from ~28.8 today to perhaps the mid-to-high 30s as forward inflation expectations return back to pre-pandemic levels.

Of course there is the risk that inflation re-accelerates - but frankly that will hit all assets classes as rates move higher. When it comes to the long end, the issue is about central bank/ government credibility in tackling inflation on an on-going basis.

Right now, the two issues to focus on are i) have we reached the peak of inflation and will it come sustainably back to target (I think the answer to that is yes - given the plethora of domestic and international data and ii) can we rely upon government/ central banks to remain credible on long term inflation control (I think the answer is also yes).

Given that, buying long dated gilts at current prices as part of a balanced portfolio represents attractive opportunity.

[Lootman]

And it is an exposure to sterling, and it carries the opportunity cost of not being in equities, that historically gives better returns.

Index linked gilts match a UK spending liability in the future. Sterling exposure is irrelevant. If the pound falls, prices rise, but you are protected against that.

Even if you never leave the UK, you still have a future spending exposure to FX because so many things are imported. So your future spending liability is not 100% sterling, but rather some mix of GBP, USD, Euro and so on.

So if you were 100% invested in UK securities of any type, that is not hedged against currency risk. Which is why a portfolio should be global. If GBP is the worst-performing major currency over the next 5 years you will wish you had hedged that with foreign holdings.

As others have stated, gilts are not the only type of bond you can hold. I have almost never held bonds as I do not have a lot of use for them, but if I did then it would be mix of UK and foreign, and a mix of government and corporate issues.

To me being 100% in gilts is not risk-free at all. At best I will barely beat inflation. I am exposed to GBP weakness versus other currencies. And I miss the opportunity for greater returns from equities.

[air04]

I confess that in my non-pension investments, I even have some cash these days! But if someone can kindly point me at an alternative asset that will definitely be up 5 or 6% in nominal terms by this time next year, I'd switch in a flash

With the current market expectations, I would say that money market funds/etfs should be able to give close to 5%. They track the Sonia rate See https://www.youtube.com/watch?v=hnFnm-HPjGw for details.

https://www.moneysavingexpert.com/savin ... /#1yrfixed
There are fixes and notice accounts too.

[GeoffF100]

Even if you never leave the UK, you still have a future spending exposure to FX because so many things are imported. So your future spending liability is not 100% sterling, but rather some mix of GBP, USD, Euro and so on.

The CPI includes foreign goods. Index linked gilts protect you against increases in prices of foreign goods (as a result of a falling pound or otherwise). You can, however, lose out if the percentage of your spend on those goods is more than the average.

So if you were 100% invested in UK securities of any type, that is not hedged against currency risk. Which is why a portfolio should be global.

The main reason for not investing 100% in UK equities is a lack of diversification. Nonetheless, the FTSE 100 gets about 70% of its earnings overseas, and is not subject to withholding tax. A UK bias also reduces portfolio volatility (in GBP) a little.

Vanguard research indicates that for a UK based investor, it is best to GBP hedge bonds, but not equities.

[GoSeigen]

Right on cue US long-term bond yields up sharply today with the ten-year at 4.2% after a nine-month breather; a good cliffhanger for the weekend as it's poised to break through last year's highs. Will be interesting to see if there is follow-through next week, or will there be a period of testing the high?

Curious to see if this is how the yield inversion will get resolved, with long-term yields rising to overtake short-term yields. Fascinating setup for [saddo] bond-watchers.


GS