Remember the Great Rotation?
Neither does the bond market.
At the beginning of the year, all of the chatter was about a structural “rotation” of investor moneys out of U.S. Treasuries and into the stock market.
At the time, we were a few months into a rally across the risk asset spectrum, the economic data were generally coming in above expectations, and Treasury yields were rising as investors sold off their holdings of government bonds.
The “Great Rotation” story has fizzled out pretty quickly, though – as the chart below of the yield on the long bond shows – and sentiment has shifted decidedly in the other direction.
Russ Certo, who heads up rates sales and trading at Brean Capital, says he was surprised by the “steadfast bullishness” toward bonds as an asset class that came across in conversations with several clients yesterday.
“It’s very rare in my career of over 20 years that a nucleus of people are all on the same side, bullish,” says Certo. “They’re always bearish – sometimes there is a consensus view that is bearish, but I rarely find a consensus view that is bullish, particularly on the high end of the range.”
After all, here we are at the tail-end of a decades-long rally in the bond market. It’s easy to look at a long-term chart and conclude that there isn’t much value in the space. This is always a big discussion every time yields lurch lower.
Certo points out that while U.S. government bonds may be richly valued relative to history, though, they certainly aren’t richly valued relative to many of their peers around the globe.
In the United States, for example, 30-year government bonds yield 2.87%. By contrast, the German 30-year yields 2.17%, the Japanese 30-year yields 1.61%, and the Canadian 30-year yields 2.34%.
Clients Certo spoke with gave a few other key reasons for piling back into Treasuries.
The first bullish argument for the bonds is the U.S. economic data.
Treasuries are one of the world’s biggest “safe haven” investments, so when economic growth slows, they tend to catch a bid.
“[The] general belief is that growth and data will ‘roll over’,” says Certo. “[The clients] just think, first and foremost, that 2013 will be characterised by slow growth, all the way through.”
The Citigroup Economic Surprise Index just went negative this week. If it continues to trend downward, as it usually does for a little while after breaking below zero, that means economic data will start coming in further and further below consensus expectations.
In addition to the fundamentals, there are some technical factors to consider.
Certo says there was a perception among his clients that investors were “broadly underweight” bonds.
And with the Federal Reserve buying up so much of the market, it’s made it harder for investors to get back on the right side of the trade.
“There are some other people apparently trying to taper back some shorts, but there’s just not enough paper for them to grab onto to move the needle,” says Certo.
One reason for owning bonds that emerged from Certo’s discussion was particularly curious, and it follows from the argument that the economic data is starting to roll over and growth is slowing.
Certo says rising debt-to-GDP ratios were cited as a reason to be invested in Treasuries, given “off-balance sheet debt pushing the U.S. above [the 90%] threshold and unprecedented world debt-to-GDP off the charts.”
That 90% figure, of course, comes from a controversial study by Harvard economists Carmen Reinhart and Kenneth Rogoff finding that high levels of debt relative to GDP slow economic growth.
The Reinhart/Rogoff study took a significant reputational hit this week when researchers discovered that the influential study made an Excel error in calculating the figures that led to its ultimate conclusion.
Nonetheless, some clients aren’t convinced.