Bond market ‘Armageddon’ draws nearer

Co-founder of the Switzer Report
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The next big bear market – in bonds – is well underway. I have been warning about this and the potential capital losses that SMSF trustees face for some months now. Unfortunately, this latter possibility is not always appreciated. (See our 26 November edition of the Switzer Super Report – ‘Beware the bond market trap’)

While last week’s employment data was a little bit too good to be true – (of the 71,500 new jobs created, 53,700 were part-time jobs, and according to the ABS, about 90% of the employment growth came in NSW and Victoria) – bond yields rose in response to the data as the market realised that short-term interest rates are close to the bottom. Further rate cuts are becoming increasingly unlikely.

What does it all mean?

In fact, 10-year Australian Government bond yields have been rising for some time now, from a low of 2.70% in July last year, to close on Friday at 3.62% (see Chart 1 below). This increase of almost 1% in yield translates to a change in the price of the 10-year bond of 7.8% – that is, from $100 to $92.20 – which is a bit like saying the stock market has fallen from 5,100 to 4,700!

In the USA, the trend is even more pronounced. Off a much lower base, US 10-year treasury bonds are back around 2.0%, having fallen as low as 1.4% last year (see Chart 2 below).

The US, Europe and now Japan are essentially singing from the same hymn book – they are going to do “whatever it takes” by effectively printing money to get economic growth (and inflation) on the rise. As confidence improves, asset prices (stock markets, and now property) are moving higher and at some stage, interest rates are heading the same way. The bond markets know this.

The risk for the fixed-income investor has always been that this rise in bond yields was going to come sooner than the Central Banks may have led us to believe. And as the yields had reached such ridiculously low levels, the inevitable bear market could be ‘Armageddon’ in nature.

I am not suggesting that this is either imminent, or will be quite of that magnitude. However, on a risk/reward basis, there doesn’t seem to be a lot of “upside” in holding fixed-income investments, and with a clear upward trend in bond yields now in place, defensive strategies are the order of the day.

Defensive bond market investment strategies

  1. Don’t invest in fixed rate bonds – do invest in floating rate bonds/notes.
  2. If you have a portfolio of bonds or other fixed-interest securities, shorten the duration of the portfolio by either selling your longer term holdings, or by switching from longer maturities to shorter maturities.
  3. If you are a term deposit investor, when re-investing, stick fairly short term – no more than 12 months. Forget five year or longer terms.
  4. Now is a great time to borrow – so if the strategy of your SMSF is to borrow to invest in the property market – borrow fixed rate for term.
  5. And if you have an investment in a fixed income or bond managed fund, check the benchmark index the fund tracks its performance against. If it is benchmarked against one of the longer indices (for example, any of the ‘All Maturities’ indices), either consider redeeming the investment, or switching into a fund benchmarked against the ‘0 to 3 year’ or ‘Bank Bill’ indices.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Also in the Switzer Super Report

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