Friday, January 4, 2013

Contrarian Trade: Buy Bonds?

As regular readers of Random Glenings are aware, I have been bearish on bonds for at least a year.

I believe that today's bond yields are too skimpy relative to inflation to be attractive investments.  In addition, even a modest pick-up in longer term interest rates will lead to a significant drop in market value on longer maturity bonds.

As we start the new year, my bearish feelings have become the consensus among the investment community, at least as far as I can tell.  Most of the Street believes that stocks, not bonds, will be the preferred investment in 2013.

Still, it is undeniably true that interest rates moved lower, not higher, last year, and have remained stubbornly low.

Jeremy Warner wrote an interesting column in yesterday's London Telegraph asking the question "If bonds are a bubble, why haven't they burst?".

He discusses the contrast between the widespread bearish sentiment on fixed income and the impressive performance of bonds.  Perhaps, Warner writes, there is a large segment of the investor public that does not believe growth will be return this year:

...In any case, one of the most fashionable calls among investment analysts right now is that at some stage in the next 12 months, we’ll see the start of a great rotation out of bonds and back into equities. 

 Certainly, it is quite hard to believe bond yields could sink any lower. But here’s a question. If everyone thinks government bonds are a bubble riding for a fall, how come it’s not already happened?

Warner goes onto write:

So to bet on a significant rotation {from bonds to stocks} is also to bet on the return of growth. 

Well, everyone hopes for the best, but beyond the bounce in equity markets, which may be more driven by hunt for yield than faith in rip-roaring earnings growth, evidence for it is pretty thin on the ground. 

Could bonds be the contrarian trade for 2013?