The bond bear market at an impasse
Author: David Stonehouse
February 13, 2019
Government bond yields have rebounded in January following a year-end decline that pushed them down from cyclical highs, but the bear market in government bonds is at an impasse and may not have much more room to run.
The yield on 10-year U.S. treasuries dropped to roughly 2.56% at the beginning of the year from 3.24% in early November on growing concerns about the health of the global economy. Increasingly worried about the U.S. Federal Reserve’s tightening policy and ongoing trade tensions between the U.S. and China, many investors fled riskier stocks to seek refuge in government bonds.
Trepidation about Fed tightening has abated and tariff discussions appear to be progressing in fits and starts, leading to a swift rebound in stocks and renewed rise in bond yields through January. The about-face has been driven by the Fed’s recent assurances that it will take a more cautious approach to future rate hikes, as well as cautious optimism that the U.S. and China may finally be prepared to resolve their ongoing trade dispute.
With Brexit and other tenuous geopolitical events continuing to unfold in Europe and around the world, this latest “risk on” phase is likely running into more challenging territory, which should cap the rise in yields. However, several factors may also limit their room to decline much.
It would probably take a more severe economic slowdown or outright recession to induce another big rally in bonds and drag yields significantly lower from current levels. And while such an outcome is clearly a concern at this late stage in the cycle, it’s one that we do not expect to play out in 2019 – especially now that the Fed is tempering its tightening program.
By the same token, meaningfully higher yields from here are by no means inevitable. Economic growth has undoubtedly waned in recent quarters and signs of further weakness are evident across many areas of the global economy, including Europe, China and the U.S. housing and automotive sectors.
This, combined with the current transition to a more volatile period for equities should keep yields from rising much higher. If anything, the past few months have been an important reminder to investors of the diversification benefits that bonds can provide when stock prices turn sour.
Furthermore, as Treasury yields have risen over the past couple of years, so too have the coupon rates associated with them, resulting in a much more appealing backdrop for bonds versus their 2016 nadir.
As a consequence, the cyclical bear market in bonds that began more than two years ago is long in the tooth and running out of steam in much the same way as other periods of prolonged selloffs. Cyclical bears have typically lasted close to 21 months since the 1980s and run their course after U.S. 10-year Treasury yields have risen nearly 2.25% on average, according to Bloomberg data. The current cycle, by comparison, has lasted approximately two-and-a-half years with the climb in 10-year yields not quite 2% based on the high – and what may well be the cyclical peak — in November.
Cyclical bear markets: This rise in 10-year U.S. Treasury yields
Source: Bloomberg LP as of November 1, 2018. Based on month-end data.
Bond returns, meanwhile, have been commensurate with history during this current bear cycle and not nearly as bad as many have been fearing.
Cyclical bear markets: 10-year U.S. Treasury returns
Source: Bloomberg LP as of November 1, 2018. Based on month-end data.
Ultimately, sentiment towards the bond market has perked up in recent months, but still remains far from being euphoric. This seems about right. While the worst of the bear market in bonds may be behind investors, putting money to work in the asset class remains a challenge and will continue to require a disciplined approach to be effective.
U.S. Treasury futures vs. Ned Davis Research (NDR) Daily Bond Sentiment Composite
Source: Ned Davis Research as of February 8, 2019
David Stonehouse is a Senior Vice-President and Head of North American and Specialty Investments at AGF Investments Inc. He is a regular contributor to AGF Perspectives.
Commentaries contained herein are provided as a general source of information based on information available as of February 8, 2019 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), Highstreet Asset Management Inc. (Highstreet), AGF Investments America Inc. (AGFA), AGF Asset Management (Asia) Limited (AGF AM Asia) and AGF International Advisors Company Limited (AGFIA). AGFA is a registered advisor in the U.S. AGFI and Highstreet are registered as portfolio managers across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF AM Asia is registered as a portfolio manager in Singapore. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.
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Written by
David Stonehouse, MBA, CFA®
Senior Vice-President and North American and Specialty Investments
AGF Investments Inc.
