Business Administration

Bond Market: Beware the bubble

After the tech bubble of the early 2000s and the housing bubble in the U.S., the specter of another bubble threatens the savings of investors: one who is forming in the bond market.

Behind the sense of security that bonds provide lurks a danger: that of a deflated bond prices, experts say.

Here’s why. In response to the financial crisis of 2008, investors left the stock market to take refuge in the bond market. Result: the demand for this asset class has boosted prices and reduced yields dramatically. In the U.S., yields on government bonds of 10 years is down to 2.9% in July, an historic lows well below the average yield of 4.44% posted by these obligations during the 2000s.

Rush bond funds

Between June 2009 and June 2010, investors withdrew 6.7 billion Canadian dollars ($ billion) fund shares and bought $ 11 billion of bond funds, according to the Investment Funds Institute of Canada. Scenario similar to the United States. During the same period, investors pulled U.S. $ 9 billion of U.S. equity funds and bought $ 376 billion U.S. bond funds, according to Investment Company Institute.

Of anxiety in the air

Experts are worried. “Investors do not realize maybe not, but in this context, they face a risk in investing in the bond market,” said Gabriel Lancry, Associate Administrator, Wealth Management, and Advisor at ScotiaMcLeod. “It will be difficult to achieve positive returns in the short term if interest rates historically low, are increasing.”

A mere 1% increase in interest rates could for example bring the price of a 10-year bond provided with a coupon of 3%, 100 to $ 92.90 (a decline of 7.1%).

“The risk is real, since historically inflation resurfaced after a takeover,” said Mathieu D’Anjou, senior economist at Desjardins Group. That pushes central banks to raise their prime rate, which causes a drop in bond prices, especially long term. ”

Other experts fear, a fall in the bond market occurs. Indeed, some forecasters are not convinced that the output of recession will occur as the previous recoveries, and even foresee deflation.

“If inflation remains around 1% long-term Government bonds, at current rates, remain attractive,” says Jean-Luc Landry, portfolio manager at Landry Morin, in its latest financial newsletter.

Yvan Fontaine, Senior Vice President and Co-Chief Investment Officer at Addenda Capital, also remains optimistic. The market is expensive, he admits, but one can not see the characteristics of a bubble.

“Usually, a bubble is created by investors seeking high yields. Now, an obligation of the Government of Canada five years reported only 2.25% today,” said one whose firm managed, June 30, assets of $ 34.3 billion consisting primarily of bonds.

States could to tilt the market

If the direction interest rates will be crucial for the bond market, another danger looming on the horizon: the massive issuance of bonds by the different levels of government.

To fund their rescue packages for banks, their recovery programs and the budget deficit widened by recession, the world’s governments sell bonds. If supply exceeds demand, bond prices will fall, warns Mr. D’Anjou. “We are already seeing this phenomenon in European countries in difficulty, such as Greece and Spain, where bond prices fell and bond yields rose.”

According to Mr. Fontaine, Canada is more immune to shocks than other countries bond. Why? The demand for bonds is such that it compensates for the offer. “Foreign demand has been particularly pronounced in Canada,” he says.

Canadian bonds are very popular because of financial problems in European countries. Investors who sulked while the Old World have favored Canada and Australia.

LESS DANGEROUS THAN A Stock Market Crash

A bond market crash can be a blow to savers, but not as much as the bursting of a bubble market.

“A bond bubble is not as dangerous as if the issuer does not go bankrupt, the investor will continue to receive his interest coupons,” said Alain Roch, President of Blue Bridge. For cons, the economic value of these coupons, that is to say their purchasing power could be less if inflation is higher. ”

For example, the interest rate of U.S. government bonds of 10 years amounted to about 2.9%. If inflation rose to 3%, it would be impossible to draw a positive net return. By cons, as the redemption price of the bond and the coupon are known in advance, investors will receive the expected gain due, unless the issuer is no longer able to pay.

Because of these characteristics, a bond bubble is called “defensive bubble”. “Investors have sought refuge in these securities to protect their capital, since they do not achieve high yields,” said Mathieu D’Anjou, senior economist at Desjardins Group. The fear of a new bear market has pushed to opt for monetary investments which earn almost nothing and bonds with a yield of 2% on average. ”

The investment behavior was different when the technology bubble of the early 2000s. They pounced on the actions of the related sectors of information technology in the hope of making quick strong gains.

No sudden drop fear

A bull market is unusual to deflate suddenly. Thus, the Nasdaq index fell from a high of 5,048 points to below 2,000 points between March 2000 and September 2001. It currently stands at about 2300 points.

For its part, the bursting of the bubble bond will be slow, because rising interest rates and bond will gradually, “says D’Anjou.

However, after 10 years, a large number of bonds will be due. The investor who chose high-quality issuers may then renew his portfolio by buying bonds more attractive.

Thus, an investor aware of the danger could structure its portfolio to protect their capital against the bond bubble. For example, it could focus on short-term securities and high credit ratings. In summary, it is possible to escape.

FIVE WAYS TO PROTECT YOU

1. Avoid long-term bonds
“The bonds maturing in 10 years and older are more risky now because their prices fall more than short-term bonds when rates rise,” said Gabriel Lancry ScotiaMcLeod. To protect yourself, diversify the maturities of your bonds, so that investments come forward year after year. Thus, if interest rates rise, you can buy bonds that offer higher yields. In so doing, reduce the average maturity of your bond portfolio to five years or less.

2. Souspondérez the federal government’s obligations
The Canadian government bonds are currently earning less, according to Mathieu D’Anjou, Desjardins Group. “Municipal bonds, provincial and companies are more attractive, especially if there is a sustainable economic recovery.”

3. Buy Solid
“The challenge is to find safe bonds,” says Lancry. An example? U.S. bonds could lose their status as a safe haven if the Obama administration does not take action to improve public finances. To mitigate risk, avoid too much focus your capital in an issuer or a sector, recommends Alain Roch, Blue Bridge.

4. Careful with bond funds
“Instead of investing in bond funds buy bonds directly, because you control the risk better,” says Roch. You know, for example, which are the issuers and what is the average maturity of bonds in the portfolio.

5. Bet on dividends
“Reduce your exposure to bonds by buying preferred shares and ordinary shares that pay healthy dividends,” suggests Mr. Lancry. You will ensure a regular income.

Business Administration

Bond Market: Beware the bubble

Related Posts: