Bond Investors Worry This Is as Good as It Gets -- Update
October 14 2019 - 6:32PM
Dow Jones News
By Daniel Kruger
This year's global debt rally has left some investors wondering
if the biggest gains are in the rearview mirror.
U.S. government debt has returned 7.3% this year counting price
changes and interest payments -- well above the 2.2% average for
the previous 10 years, according to Bloomberg Barclays data. This
year's 13% gain in corporate bonds is more than twice the 6.1%
average since 2009, while high-yield debt has appreciated 11%, not
far below its 13% annual average for the same period. The total
return for the S&P 500 is 20% for the year so far.
Now, some investors are concerned that bond prices have risen so
much that they have little room to increase further. Boosted by an
unusual combination of steady economic growth and Federal Reserve
rate cuts, the yield on the benchmark 10-year Treasury note -- the
percentage investors expect to earn annually from buying the bonds
-- now stands around 1.7%, within 0.4 percentage point of its
all-time low. Yields fall when prices rise.
At the same time, the extra yield investors demand to hold both
investment- and speculative-grade corporate debt instead of
relatively safe Treasurys stands near multiyear lows.
For Treasurys to notch further gains, the economy will likely
have to show new signs of deceleration, some investors say. That
could hit corporate and junk bonds, which investors tend to sell in
times of economic weakness. The reverse is also true: A surge in
growth that boosts corporate bonds would likely dent gains in
Treasurys.
"This is the quandary for taxable [bond] investors like
ourselves," said Bryce Doty, a bond manager at Sit Investments.
"I've been telling my customers this just isn't sustainable."
Recession worries and interest-rate cuts from the Fed have
boosted bonds of all kinds this year. But worries that the gains
can't go on forever have led some investors to unusual corners of
the market. Mr. Doty said he has added taxable bonds sold by states
and local governments, which offer more attractive yields and
stronger credit quality than most company debt or the tax-exempt
bonds typically sold by municipalities.
Investors say they are also worried that a slowdown in global
growth caused by rising trade tensions could lead to a contraction
in corporate profits. Analysts expect earnings for companies in the
S&P 500 to fall about 4% for the third quarter, according to
FactSet data, in what would mark the biggest quarterly
year-over-year drop since 2016.
Even with default rates well below historic averages, falling
profits could push investors to demand higher yields on corporate
bonds, eroding some of the recent gains. And some investors said
the strength and duration of the rally make it hard to tell which
bonds in what sectors of the economy will hold their value in a
selloff.
"You can't look at the market and say, ooh, this is a good
value," said Nancy Davis, chief investment officer at Quadratic
Capital Management. Ms. Davis manages an exchange-traded fund, the
Quadratic Interest Rate Volatility and Inflation Hedge ETF.
The fund, which invests in Treasury securities whose returns are
indexed to inflation and bets on how bond prices will swing as
expectations for Fed interest rates change, has gained 2.3% since
its inception about five months ago. Ms. Davis expects bigger gains
as returns on government and corporate debt stall.
Some investors also worry that a surge of economic optimism
could hurt both government and corporate bonds. That is because an
improved outlook could lead investors to sell holdings of safe
government bonds, driving prices down for them as well as for the
debt of the safest companies.
"We've had such strong performance this year, you have to temper
expectations about what future returns will be," said Kathy Jones,
chief fixed-income strategist at the Schwab Center for Financial
Research, a unit of Charles Schwab Corp.
Many individual investors have taken that sentiment to
heart.
With an investment in fixed-income assets, investors typically
"don't expect much in terms of its return potential, but we know it
keeps us safe," said Patrick Rush, chief executive officer at Triad
Financial Advisors Inc.
Write to Daniel Kruger at Daniel.Kruger@wsj.com
(END) Dow Jones Newswires
October 14, 2019 18:17 ET (22:17 GMT)
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