By Mike Dolan
LONDON, Feb 22 As effervescent new year markets
turn flat in February, doubts have resurfaced about whether the
mass exit this year from hyper-expensive government bonds feared
by some will occur.
Few strategists doubt investors with long horizons who are
willing or able to tolerate the more volatile world equities
will eventually be rewarded if they emerge blinking from likely
loss-making "havens" of U.S., German or UK government bonds.
But if, as many insist, safe-haven bond demand is
structural, increasing and relatively insensitive to returns
then, rather ominously for savers and underfunded pension plans,
ultra-low benchmark bond yields may be more accurate and durable
and suggest low long-term returns everywhere else too.
In several deep-dive studies into decades of investment
returns, few doubt the relative return picture. Over 5, 10 or
even 30 years, the chance of losing money by remaining in
Treasuries, bunds or gilts - which have historically low yields
even as central banks policies press furiously for reflation -
is higher than moving to equity.
As part of its 58th annual "Equity Gilt Study" released this
week, Barclays reckoned over the next five years, low returns
everywhere would remain the norm. But inflation-adjusted annual
losses of 1.5-2.0 percent for cash and "safe" government bonds
would be outstripped by gains of 3-4 percent in equity.
A 10-year view from Standard Life Investments last month
concluded best-case real total returns on U.S., UK or European
government bonds would be little over 1 percent per annum but
annual losses could be up to 4 percent in Treasuries and gilts.
Credit Suisse/London Business School's Global Investment
Returns Yearbook looked out 20 years and said an historically
pale 3-3.5 percent annual equity return forecast would still
exceed the zero yields on 20-year inflation-linked U.S.
Treasuries or negative yields on 20-year index-linked UK gilts.
WHY NOT ROTATE?
So, should the herd scatter then in this year's much-vaunted
"Great Rotation" and will bonds quickly unwind their 20-year
bull run with a sharp spike in yields on the horizon?
For a start, households and pension funds will at least be
hesitant exiting the bunkers after the credit crisis air-raids
of the past five years. This week's wobbly global business
surveys for February and political stand-offs across Europe and
in Washington are all reminders that economic recoveries never
happen in straight lines or are guaranteed.
And even if the U.S. Federal Reserve is thinking aloud about
how and when it might wind down its bond-buying, or quantitative
easing policy, few see it doing so this year. The Bank of Japan
is ramping up its QE programme in the meantime and even the Bank
of England governor is still in favour of another UK round.
But the biggest barrier to a mass withdrawal from
return-free bonds is the still-growing demand for "safety" from
players relatively insensitive to prices and returns.
Barclays economist Marcus Gapen focusses on three big buyers
of U.S. Treasuries on "safety" grounds - reserve managers at
foreign central banks intolerant of risk, commercial banks under
regulatory pressure to build "safer" liquid assets and bolster
capital ratios, and aging households unwilling to risk
retirement savings in more volatile equity.
Gapen calculates that the pace of reserve accumulation by
China and others - and hence their demand for government debt to
bank that hard cash - may have peaked as they liberalise and
rebalance their economies. However, the other two sets of buyers
would more than offset set any drop-off in bond demand.
BANKS, BOOMERS AND BONDS
Even given last month's extension of deadlines for new Basel
Committee bank rules, Gapen estimates domestic and international
regulatory pressures could see U.S. banks alone increasing
holdings of liquid securities by $100-200 billion per annum.
And as the peak retirement period for the U.S. post-war baby
boom generation around 2020 approaches, these older households
will be less willing to put or leave savings at risk as they
prepare to draw on them for consumption within 10 years.
Gapen shows that by 2010 'older' households - defined as
those headed by someone aged 55 or over - already made up almost
two thirds of total household net worth in the United States and
almost two thirds of total financial assets. And this grouping -
projected to be nearly half of all U.S. households by the end of
the decade - will shorten its investment horizon and most likely
step up bond buying in the coming years.
"Demand for safe havens will remain robust, even in an
environment of low to negative inflation-adjusted returns,"
Gapen concluded, adding this added market support to structural
drop in the supply of top-rated "safe" assets.
Along with central banks' QE, this goes some way to
explaining what appears in historical perspective to be
bubble-like pricing in bonds, the Credit Suisse/LBS report said.
"Many alleged distortions are likely to be permanent," wrote
authors Elroy Dimson, Paul Marsh and Mike Staunton. This
"safe-haven demand for bonds could even increase."