The bull market in U.S. bonds and other developed countries stretching over 30 years has given rise to a “cult of bonds” among owners of financial assets, says Nicholas Colas, ConvergEx Group chief market strategist.
“The last five years in capital markets have been tumultuous, and the most crowded port in this storm has been fixed income investments,” he wrote in a recent note.
During that period, investors have pulled nearly $550 billion from U.S. stock mutual funds while plowing over $1.3 trillion to taxable fixed-income funds and ETFs.
“Based on the money flow data … combined with the Fed’s newly announced purchases, fixed income seems destined for another year of reasonable returns in 2013. At the same time, this is becoming a crowded trade. The lackluster state of the U.S. economy makes inflation an unlikely pin to pop this bubble, at least in the next 12 months,” Colas wrote.
“But if you are looking for non-consensus worries about the next 12 months, higher interest rates are a good place to start. Given how much capital has plowed its way into the fixed income market, it is probably naïve to think that a dramatic move higher for rates would be received with a shrug or a redirection of capital flows into riskier assets such as stocks,” the strategist concluded. “If the past decade teaches anything, it is that investors move further away from the fire when burned. As the old Wall Street saying goes, ‘They don’t ring a bell at the top or the bottom.’ For 2013 to be a good one for risk assets, we better not hear any bells in bond land.”
2013 rate outlook
At U.S. banks, the Treasury bond market’s 21 primary dealers are forecasting rates will rise in 2013, according to a Dow Jones Newswires survey.
They see a median 10-year yield of 2.25% at the end of 2013.
“The higher yield, which means lower prices, reflects these banks’ expectations that the U.S. economy will not only emerge largely unscathed from year-end budget negotiations to avert a mix of spending cuts and tax increases that could send the economy into recession if they take effect next month, but also gain momentum, particularly in the second half of the year,” according to the report.
iShares Barclays 20+ Year Treasury Bond Fund
Full disclosure: Tom Lydon’s clients own TLT.