End of Bull Run Will Be Cause for Celebration

Anyone who puts their head above the parapet to offer a view on the direction of the markets knows they run the risk of being made to look foolish. It is an occupational hazard. In my experience most pundits get more criticism for making the right call at the wrong time (typically too early) than they do for making the wrong call and sticking to it when it goes sour.

You rarely get fund management or journalism awards for being right in the wrong calendar year, any more than you would expect to get a big bonus at an investment bank for making a great (but premature) market call outside the annual bonus cycle. This phenomenon is part of the broader trend towards short-termism in financial markets which the Kay Review is currently examining.

Yet managers and advisers, if they are doing their job properly, should, I think, be rewarded more handsomely than they are for being right at the wrong time. The appropriate time horizon for most clients is considerably longer than the 12 months for which performance bonuses and industry gongs are typically distributed. Few seem to be as grateful as they should be for dodging the worst market breaks. More often than not, they have spent the previous period berating their advisers for failing to have chased the latest market trend to its highest point.

Those who started to steer clear of western government bonds a year or more ago, on fears that the 30-year bull market was finally nearing its end, will be more than familiar with this phenomenon. Government bonds, at the long end especially, were one of the best performing asset classes in 2011, yet to buy conventional US or UK debt at their start-of-year prices 15 months ago was, for many professionals, simply a step too far. Those who cut their bond weightings to the bone were left well behind in performance.

This year they may yet be vindicated. Eighteen months ago I wrote a piece here suggesting that it was time to start looking forward to the end of the great bull market in bonds. At the time I was fully aware that my comments were likely to make me look stupid, and prudently included a get-out clause, to the effect that in the short term bond yields could well go sharply lower still, as markets so often do ahead of major turning points.

But if they did so, I suggested, it would be less a case of fundamentals asserting themselves than a trading opportunity for investors taking advantage of some exceptional circumstances, and buying on the Greater Fool Theory, confident that they would be able to exit later, before the bond bubble itself deflated. That remains my view, even though bond prices have continued to perform well in the interim. (The argument for index-linked bonds, even on negative real yields, is a different and more complex subject).

What has changed the game since has been, first, the eurozone saga  (dragging on longer and more damagingly than most thought possible) and secondly, the global impact of quantitative easing which has simultaneously distorted bond prices along the yield curve and created two new classes of price-indifferent bond investor – regulated-to-the-point-of-stupidity insurance companies and broke-but-too-big-to-fail banks, who have been forced and bribed (respectively) to buy and hold all the bonds that no sensible investor could rationally justify acquiring. Behind them, in turn, as the buyers of last resort, stand wildly inflated central bank balance sheets of unknown resilience.

Are we now seeing the first signs of a final, fatal crack in the great government bond market bull market of the past 30 years? Will George Osborne’s floating of the idea of a 100-year gilt issue in the UK come to be seen as the bond market’s equivalent of the Time Warner-AOL deal of Q1 2000, the point that marked the final peak of the bond market cycle? It is tempting to think so after the events of last week, when US Treasury yields spiked up sharply.

Mid-March has of course become a traditional date for big equity market turning points (think 2000, 2003 and 2009). Is it now the bond market’s turn? The strategists at GaveKal think so. Just a few days ago they issued a note arguing that the bond market, as well as being heavily oversold, was now at risk of a decisive downward break. In the worst case, so Tim Bond of Odey Asset Management suggested more than a year ago, there is a real risk of a rerun of the bond market “rout” of 1994.

I am not yet entirely convinced. One sharp correction alone does not establish a turning point. It is only a year ago that 10-year Treasury bond yields were at 3.5%, so last weeks’ climb back to 2.3% (from a low of 1.7% in September) cannot yet be described as climactic. The central banks still have plenty of room to twist and distort the bond market. The economic environment is improving, but remains fragile, especially in Europe. There are several potential flashpoints in strategically sensitive parts of the world.

But what remains the case is that we need a decisive break in the bond market before we can begin to think that we are finally through the trough of the economic fallout from the global financial crisis four years ago. In that sense a sustained bond market retreat, if it happens, will be good not bad news – even if last week’s events, as seems possible, prove to be only the beginning of the end of the cycle, and not necessarily the absolute turning point.