Despite a rare multi-year drubbing – or perhaps because of it – bonds are poised to outperform equities over the next 10 years, according to a new Man Solutions analysis.
In another contribution to the perennial bond v equities discussion, now peaking along with interest rate expectations, portfolio manager with the UK-based firm, Henry Neville, cites history as on the side of the former.
Neville says global bond indices are headed towards a three-year losing streak in a bond rout for the ages and one of the worst on record.
“Prior to now there have only been five instances of three consecutive years or more of negative performance (I refuse to count 2016-18),” Neville says. “The total drawdown in this one is already greater than any of the others bar 1916-20 and 1977-81. This one’s for the mean-reverters.”
But for investors not sold on mean-reversion, the Man paper lays out four other reasons to buy long-term bonds including cheap pricing relative to equities, “extreme” valuations compared to economic fundamentals, and out-of-whack positive correlations with shares.
Plus there remains an “outside chance of stuff blowing up””, Neville says, in a piece produced just prior to the Hamas incursion into Israel.
“… there’s still a war on in Europe. Meanwhile, despite one of the most rapid increases in mortgage rates ever, US house prices are off their peak by… Oh wait. They’re not,” he says. “I could go on. Point is that there’s a bunch of stuff that could explode. Probably more so than usual. And if that happened people would rapidly re-discover the flight-to-safety properties of US Treasuries.”
US 10-year bond yields eased last week from a high of about 4.8 per cent to just above 4.6 per cent in the wake of the Israel-Hamas conflict and hints the Federal Reserve hiking cycle was at an end.
Regardless, Neville says the force of history and the weight of numbers suggest bonds might offer a good buying opportunity over the next 12 months.
“Through the last four Fed hiking cycles the UST10 yield has fallen by a median of 80bps in the 12 months following the last hike (ranging from -17 to -98). We are at least close to the last hike. More likely beyond it, in my view,” he says.
“The duration of the Bloomberg Barclays US Treasury 7-10 Year Index is currently 8. So if we get the median historic scenario from here you get 6% return on the yield move. Plus 4% carry. Equals a decent base case of 10% return.
“Or you go for US equities at 19x on a hope and a prayer of an AI productivity revolution. Soon. I know what I’d choose.”