Page 12 - ISQ UK_October 2017

INVESTMENT STRATEGY QUARTERLY

Optimism, Pessimism

and Today’s Bond Markets

Chris Bailey, European Strategist, Raymond James Investment Services

I remember being taught about the reverse yield gap, the
notion that existed before 1959 that riskier equities should “ Surprise is the greatest gift which life can
yield more than safer bonds, during my days as an grant us ”
Economics undergraduate. Back then the weight of over – Boris Pasternak
thirty years of empirical realities that investors were
seemingly prepared to accept much lower yields on

equities versus bonds due to the former’s scope to grow There are three key reasons why bond yields have compressed so
had become gospel. However, for much of the last decade, much in recent years. The first is the improved demand-supply
equation courtesy of another dusty economics textbook concept
fixed income markets have had their own Back to the Future
- quantitative easing. This has more than soaked up any higher
moment and, at least in the developed world, have gone government deficits. The second is that inflationary concerns at
back to pre-1959 norms offering typically much lower all major global central banks are currently deeply suppressed,
leading to an elongation of the ‘lower for longer’ interest rate
yields than local equity markets.
cycle. This is good news for any fixed principal investment. The
Now this poses a bit of a conundrum for the typical multi-asset third aspect is linked to one reason why there is a lack of overt
investor. The bond markets have been the default lower volatility inflationary concerns currently - anticipated economic growth
stalwart of portfolios for a long time now and the steady rates have been compressing, especially in Europe.
downward march of yields over the last generation has led to I have heard it said that a fair value guide to a medium duration
total returns that can look equity markets straight in the eye. government bond yield can be discerned by adding together the
However, the risk is that what has gone up so much may anticipated inflation rate and the economic growth rate of an
prospectively struggle. After all, bond products are fixed principal economy. Pull down future expectations for both of these two
in nature.

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