‘Crazy’ bond market set to implode, experts fear

Voices of doom have started reverberating around the investment industry as extreme low yields in peripheral European bond markets and high valuations elsewhere ring alarm bells.

Investors could face huge losses if they invest in certain assets which appear to have reached ‘bubble’ valuations levels, the fund managers have warned.

The flames of the peripheral bond rally were fanned by European Central Bank president Mario Draghi last week after he gave his strongest signal yet the bank is considering rolling out its own quantitative easing (QE).

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Italian five-year government bonds were last week trading at roughly the same yield – 1.6 per cent – as US Treasuries, implying that investors now deem the US and Italy as equally risky – a situation described as illogical by market commentators.

On a cyclically adjusted price to earnings (Cape) measure of 25.3, US equities now look expensive – they have only surpassed these levels in the market bubbles of 1929 and 2000.

Clive Hale, partner at Albemarle Street Partners, said the “most prevalent and... disingenuous” of the optimistic market views at the moment was that the European sovereign debt crisis had been solved.

He questioned whether Italian debt trading at a lower yield than the US made any sense from an investment perspective.

But while Mr Hale said markets across several asset classes looked expensive, the “euphoria” in the market could continue for some time until things become “terminally overvalued”.

Stewart Cowley, investment director for fixed income at Old Mutual Global Investors, said the low yields on peripheral government bonds are “a sign of distress, not success”.

He explained that investors were piling into peripheral debt issues “indiscriminately”, leading to “extraordinary valuations”.

However, he agreed with Mr Hale that the rally could go on for some time before reaching a tipping point. If Europe introduced QE it would buy up “any old rubbish” and cause a further rally, he said.

But the potential bubbles are not confined to peripheral European debt. Newton’s £9bn Newton Real Return star manager Iain Stewart said years of unconventional monetary policies may result in “some of the biggest bubbles of all time”.

“We are in a world where extraordinary monetary policy is being used to deal with structural issues and this is distorting prices,” he said.

“Sentiment is very high, euphoric in some areas. We are almost certain to create a bubble in something. When things become price-motivated and people need to have more just because it is going up, that is a bubble.”

Miton’s multi-asset perma-bear Martin Gray said he was positive about “nothing”, adding “everything looks expensive”.

“I think perhaps the thing that worries me the most is the bond or credit markets,” he said. “It is fairly crazy. There are too many people chasing yield.”