If this is beginning to change, if the common knowledge of the lower-for-longer world in which investors have been living since 2008 is beginning to breakdown then the pickup in yields that has already been seen in bond markets following the result of the US election could have further to run as rates rise, perhaps faster than expected.
Burgess adds: “The big question for investors is how bonds are being used. Bonds have typically been used for diversification and hedging purposes, but with increased correlation between asset classes during stressed market environments (when diversification is most needed), new methods of hedging are arguably needed.
Pointing out: “Core government bond yields are unattractive and are close to the most expensive levels in history; however, investment grade and high yield credit spreads still appear reasonable, suggesting opportunities in credit markets remain.”
Mihir Worah, Pimco’s CIO for asset allocation and real return agrees not only that nominal bonds remain expensive, but also that developed markets have clearly turned optimistic following the election of Trump.
Nevertheless, he says: “Substantial uncertainty still looms around policies that are intended by the new administration and those that will actually be enacted. While higher growth is a possibility, our view is that fiscal expansion and protective trade policy when the economy is operating near full capacity makes higher inflation almost a certainty.”
For this reason, the firm has started viewing Treasury Inflation-Protected Securities (TIPS) rather than nominal government bonds as the “risk-free” asset.
As Worah points out the change in animal spirits is predicated on a number of major assumptions, prime among them, that president-elect Trump will actually succeed in pushing through his proposed fiscal stimulus measures. And, as I already pointed out, this remains to be seen.
And, of course, as those of us currently in the midst of the highs and lows of the festive season will know all too well, after the euphoria comes the hangover. But, for now, despite the litany of uncertainties coming down the geopolitical pipe in 2017, the mood within markets seems a better match for the lofty valuations we have been living with for so long.
