ASK ANY independent financial adviser which are higher-risk – shares or bonds – and the answer will come back loud and clear.
Government bonds are a low-risk investment whereas shares are for the brave and the wealthy.
However, that is not the way Tony Hill would describe the contrast this summer. “People have been whipped around in bonds in the last few weeks,” he says.
“Try to go long of the US bond market, and you just get killed.”
Hill, a fixed interest trader for City banks for 15 years who now trades for his own account using momentum analysis, has watched shares get becalmed in tight ranges on the FTSE 100 and the Dow Jones Industrial Average, while the supposedly safer bond market has gone from bubble to burst.
The peaks and troughs have been most extreme in the world’s most important government debt market, in America, with the September US Treasury bond future climbing to a dizzy peak at 123.06 in mid- June, and then crashing 15% to a low of 104.12 last Friday.
British and continental bonds have also been clobbered, albeit not as hard.
British gilt-edged stock and European bunds have fallen some 6% in the same period, pushing up their yields and making it more expensive for their Governments to borrow from investors.
The real pain, however, has been in US Treasuries. Many short- term investors – both individuals and institutions in Britain and America – have suffered as that 15% collapse unfolded.
David “Jim” Morrison, senior dealer at spread betting company Financial Spreads, says: “We have seen a large number of clients go long of bonds since the beginning of June. They have not done very well, I’m afraid.”
Rival firm CMC/deal4free says the wild gyrations in US bonds last Friday – there was an intra-day trading range from 106.25 to 104.12 on the September Tbond – made life difficult for punters.
“Clients were long of bonds, looking for a recovery, and many of them saw their stop-loss levels hit on the way down to 104.12,” says CMC’s chief dealer, Brian Griffin. Veteran market expert Stephen Lewis, chief economist at Monument Derivatives, says he thinks that some institutional investors and fund managers have been knocked about by the US bond market stampede.
He warns the move could be ” destabilising” for the financial system. He adds: “There may be some hedge funds that have got themselves into a tangle, and we could see less favourable trading for investment banks in the third quarter.”
SO FAR, squeals of distress have not been heard in public. David Snow, editor of Hedgefund.net, says there are hundreds of hedge funds that specialise in fixed interest bond markets.
Performance figures for July will not be available for a week or two.
“I would not be surprised if some of the better managers correctly anticipated the signs of economic recovery and the rise in bond yields,” Snow says.
Some speculators are still finding themselves tempted to “pick a bottom” in the US bond market by opening long positions. Hill says: “My momentum studies suggest US bonds are due a short-term rally, perhaps taking the September future five points higher to 111 or 112. If so, there are big potential returns as well as big potential risks.”
Why Stateside prices rocketed
AMERICAN Treasury bond prices were driven skyward in the spring by hints from Federal Reserve chairman Alan Greenspan that he saw deflation as a danger. When deflation takes hold of an economy, bonds become very valuable since they offer a solid and positive interest rate.
Greenspan later back-pedalled on deflation and cut interest rates by only a quarter of a point on 25 June, disappointing the bond market’s exuberant bulls.
There were also increasing signs that the US economy might be starting to gather pace, modestly, after the standstill caused by the Iraq War.
The yield, or running interest rate, on American 10-year bonds fell to just 3.1% on 16 June, a 40-year low, but have now backed up all the way to 4.5% as their prices have fallen.
This T-bond crash reminds old hands of a similar one in February 1994, when Greenspan surprised investors with a rapid-fire series of interest rate rises aimed at cooling down a fast-growing economy.
