An insightful client exclaimed to me last week, after I had enumerated the many risks facing bond market investors, that he felt like a deer in the headlights. “Bear” with me for a paragraph or two while I elaborate. . . Imagine you’re a deer on a lonely stretch of highway late at night. To either side are high walls of rock (the psychologically difficult-to-scale barriers of asset allocation into equities). Behind is the long uphill that bonds have coasted on (with some bumps) for the past 30+ years. In front, coming closer every second is a set of large, bright headlights. Scary, huh?
The Tough Choices
You seem to have only three choices. 1) stand pat and hope that the driver sees you and comes screeching to a halt in time, 2) sidestep into the “duration lane” watching the wind of the passing truck ruffle your fur as you remain stuck in overpriced Treasuries and the market takes off, or 3) hop into the “credit lane” to try and capture higher rates from corporate bonds, avoiding getting crushed by the Treasury steamroller, but assuming more risk. Oh, and one more option: you magically transform into a tortoise (cash) and let whatever mode of transport pass harmlessly over you.
If it took too long for that vehicle to arrive, and the tortoise were actually a client, it might be open season on you. But this analogy speaks to an unease among fixed income investors, a sense of paralysis from several directions:
- After two vicious maulings from the equity markets over the last decade and a half, clients are in capital preservation mode: “I’m okay with not making a ton of money, just don’t lose me money”. It’s difficult to allocate away from what has been a winning asset class for over a generation.
- There’s a feeling that we are in an artificial investment environment, the creation of developed world central banks. Thus, it’s difficult to get comfortable with “P/E’s,” “dividend yields” etc. used to justify the cheapness of equities. I speak to this in a recent paper Living in a More Volatile Investment World, which you can read at us.pioneerinvestments.com.
- The desperate need for income. As client time horizons have shrunk, the need to live off the income generated from their assets has grown ever greater. And guess what, our vaunted politicians are likely set to make that proposition even more challenging.
A Bond Market Long in the Tooth and Questionable Issuance
Of course the fear of the headlights is equally riveting:
- A bond “bull market” that is long in the tooth combined with a Fed seemingly hell-bent on generating growth, asset reflation and is willing to live with (and some say counting on) higher inflation.
- Politicians who pay lip service to the degradation of our country’s credit standing (and who have been trained by recent experience that a credit rating downgrade drives yields lower)
- A credit market that appears to be running with its spigots wide open, with record corporate issuance, a good chunk of which is for questionable uses (equity buy-backs, dividends to private equity sponsors).
In upcoming blogs we will explore these themes and more. However, you can get a sense of where I am going by reading Pioneer’s paper I referenced earlier. Needless to say, at Pioneer,we are focused on providing solutions to investors who are grappling with the above. Please join me in the weeks ahead as we seek to rescue the “Bond Deer” in the headlights.