Star multi-manager Patrick Armstrong has warned that bond markets are now locked into a bear market that will last until the end of the decade.
The manager, co-founder of Armstrong Investment Managers, said while he expected central banks to maintain their loose policies he believed interest rates would “grind higher” - presenting the worst possible scenario for fixed income.
The manager said if government bond yields rose to normalised levels of 1 per cent above inflation then investors in securities such as 10-year UK government bonds could see a 12 per cent loss of capital.
“The most difficult thing for investors to deal with this year will be the beginning of a bear market in bonds, which we believe will last until the end of the decade,” he said.
“Apart from Japan, which is mired in deflation, investors are getting yields below inflation because of extreme risk aversion among investors, and central banks pushing down 10-year interest rates through zero interest rate policies and quantitative easing.”
Mr Armstrong added government bond yields had been roughly 1 per cent higher than inflation on average in the past 50 and 100-year time horizons.
“Should inflation stay at current levels, and bond prices immediately fall to levels in line with 1 per cent real returns, investors would see a dramatic fall in the capital value of their bond positions,” he added.
Mr Armstrong said a rapid rise in bond yields was “unlikely” in spite of his positive view on global growth, which he expects to come in at3.4 per cent in 2013 but thought there would be a “steady grind higher” in longer term rates.
“We believe central banks will err on the side of growth, and will not end their ultra-loose policies until there is overwhelming evidence of a sustainable recovery and much higher levels of employment,” he said.
“This will lead to a drawn out, slow rise in 10-year interest rates. Initially rising to match inflation, then rising to their norm of 1 per cent above inflation as central banks will eventually no longer be buyers of their country’s own bonds.
“By the end of the decade we expect the market will be demanding a significantly larger than average premium to inflation to entice investors to buy 10-year bonds.”
| 10-year yield | Inflation (CPI) | Real yield | Potential capital loss at 1% real yield | |
| UK | 2 | 2.7 | -0.7 | -11.9 |
| US | 1.8 | 1.8 | 0 | -6.9 |
| France | 2.1 | 2.2 | -0.1 | -7.6 |
| Germany | 1.5 | 2.2 | -0.7 | -11.5 |
| Japan | 0.8 | -0.2 | 1 | 0 |
Source: Armstrong Investment Managers, Bloomberg as at 14/01/13
