Duration Risk: Anatomy of (modern) bond bear markets

Transcription

1 Risk. Management. Reward. Duration Risk: Anatomy of (modern) bond bear markets Historical lessons for today s bond management (Part1: Introduction) Understand. Act.

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3 Duration Risk: Anatomy of (modern) bond bear markets Content 4 Summary 5 Bond bear market: definition 5 Bond bear market episodes in the US and Germany 8 US bond bear markets: Impact on US Treasuries 9 Bond bear markets in the Eurozone: Impact on German Bundesanleihen 11 US bond bear markets: Consequences for other asset classes 12 Bond bear markets in the Eurozone: Consequences for other asset classes 13 Bond bear markets and monetary policy 15 Economic environment during US bond bear markets Imprint Allianz Global Investors Europe GmbH Bockenheimer Landstr Frankfurt am Main Global Capital Markets & Thematic Research Hans-Jörg Naumer (hjn) Dennis Nacken (dn) Stefan Scheurer (st) Data origin if not otherwise noted: Thomson Reuters Datastream 3

4 Duration Risk: Anatomy of (modern) bond bear markets Duration Risk: Anatomy of (modern) bond bear markets Introduction (part 1) Summary This report serves as an introduction to a forthcoming series of papers examining the structure and features of modern bond bear markets in the US and the Eurozone (Germany). The second part will deal with a detailed analysis of the 23 episodes under review and the consequences of rising interest rates for other asset classes. In part three, we will look at potential lessons from historical bond bear markets for today s fixed-income management and asset allocation. Contrary to equity markets, there is no common definition of what constitutes a bond bear market. In the context of our analysis, we define bond bear markets as periods of negative nominal 6-month market returns. According to our definition, US Treasuries and German Bunds have already entered a new bear market in recent weeks. We will analyse the current environment in the context of historical bear market episodes in part three of our publication. Historically, rising central bank rates have not been a necessary condition to trigger a significant rise in sovereign yields. Only 3 % of the bear market episodes we have identified in the US and the Eurozone (Germany) coincided with higher policy rates. Several asset classes have been able to withstand periods of negative government bond market returns. In particular, equity markets and high-yield bonds tend to deliver positive absolute returns in an environment of rising sovereign rates. On a relative basis, spread segments (e. g. investment-grade corporate bonds) usually outperform government bonds during bear market episodes. Analysts, on average, have no skill in predicting forthcoming bond bear markets. Consensus interest rate forecasts tend to lag behind market turnarounds. Martin Hochstein is a member of the global Economics & Strategy team at Allianz Global Investors and has 15 years of investment experience. He joined AGI / RCM from Cominvest in June 29, where he was responsible for mutual as well as institutional (inter alia central banks) global fixed income funds and US macro and fixed income strategy. Between 25 and 28 Martin served as a senior portfolio manager for Deka Investment, managing several European flagship fixed income mutual funds. Prior to this, he was as Head of Fixed Income and Money Markets responsible for global fixed income and macro strategy at SEB Invest Germany and also member of the SEB Asset Management international fixed income strategy team in Stockholm. Martin graduates with a master s degree in business administration from the University of Siegen and is a CFA charterholder since 23. Several mutual funds managed by Martin were awarded with S&P Fund Management Ratings. 4

5 Bond bear market: definition Contrary to stock markets, there is no common understanding as to what constitutes a bond bear market. While a market correction of 2 % or more is labelled a bear market for equities, comparable definitions for bonds are often related to the magnitude of interest rate increases or central bank rate cycles. In contrast, we have chosen a performancebased definition in order to take into account the current yield level and its dampening effect on rising rates over the course of a bear market. We will also offer a detailed analysis of the big ones (periods with negative nominal 12-month returns) in the second part of our publication 1 Our study excludes pre-1987 bond bear markets for two reasons: (1) The lack of available market and detailed economic data; (2) The limited comparability between earlier and more recent episodes due to different central bank regimes, regulatory environments and market structures. 1 The sole focus on the big ones would, however, limit the number of observations (6 in the US, 5 in the Eurozone / Gemany) and our ability to draw meaningful conclusions from periods of rising interest rates. Despite the secular bull market for government bonds in the US and Germany over the past three decades, there have been several periods of significantly rising interest rates and temporary negative bond market performance. In this context, we define bond bear markets as episodes with negative 6-month nominal market return. When determining start and end points, we take local highs and lows of the overall sovereign bond market performance index as reference points. Nevertheless, when evaluating central bank cycles (part two), we will also include earlier periods of rising bond market yields. Bond bear market episodes in the US and Germany Based on our definition, we have identified 13 bear market episodes in the US since 1987 and 1 episodes in the Eurozone (Germany) since 1991 (see Charts 1 and 2). Chart 1: Performance of US Treasuries % US government bonds (rolling 6m return) average (3.25) Source: Bloomberg, BofA Merrill Lynch, Allianz GI Economics & Strategy, own calculation as of June

6 Duration Risk: Anatomy of (modern) bond bear markets Chart 2: Performance of German Bundesanleihen % German government bonds (rolling 6m return) average 3.17 Chart 3: US Sovereign bear market episodes since 1987 Period Performance Start End Days % Start End US Treasuries (> 1 year maturity) Average interest rate change in bp change in % Average Source: Bloomberg, BofA Merrill Lynch, Allianz GI Economics & Strategy, own calculation as of June

7 Chart 4: Germany Sovereign bear market episodes since 1991 Period Performance Start End Days % Start End German Bundesanleihen (> 1y maturity) Average interest rate change in bp change in % Average The time distribution of bond bear markets is skewed to more recent years. While there were 4 bear markets in the US between 1987 and 1999 (see Chart 3), we have noticed 9 episodes since then. This can be explained to some degree by the lower interest rate level over time and hence the smaller buffer of current yields to offset rising rates. On average, bond bear markets in the US (Eurozone) had a maturity of 192 (161) days with a maximum of 464 (256) and minimum of 81 (82) days. During these periods, government bond yields rose 144 (19) basis points on average, leading to negative returns of 4.91 % (4.1 %). According to our definition, US Treasuries and German Bunds have entered a new bear market in recent weeks, with rolling 6- and 12-month returns currently negative in both markets. 7

8 Duration Risk: Anatomy of (modern) bond bear markets US bond bear markets Effects on Treasury performance and yield curve The magnitude of interest rate increases along the yield curve differs significantly during bear markets. On average, yields in the belly of the curve recorded the steepest surge of all maturities. In 85 % of the bear market episodes, the belly was the relative underperformer within the curve (see Charts 5 and 7). This is explainable to a large degree by the value of convexity. More convex bonds or combinations of bonds (like curve wings vs. curve belly) tend to outperform during bond bear markets due to the corresponding pickup in market volatility. While bonds with up to 3 years maturity were able to record positive absolute returns in 5 out of 12 observations since 1993, the performance of longer maturities was always negative (see Chart 5). Chart 5: US Treasuries Performance during bear markets average return (%) days (t = : start of 12 US Treasury bear market episodes since 1993) 1 3 y maturity 3 5 y maturity 5 7 y maturity 7 1 y maturity >1 y maturity Chart 6: US Treasuries Evolution of yields during bear markets average change (%) days (t = : start of 13 US Treasury bear market episodes since 1987) US Treasury yields (>1 year) +1 standard deviation 1 standard deviation 8

9 Chart 7: US Treasuries Yield increase during bear markets basis points maturity (years) Average rise of interest rates during 12 US Treasury bear market episodes (since 1993) Bond bear markets in the Eurozone (Germany) Effects on Bund performance and yield curve Bond bear markets in the Eurozone (Germany) are not isolated events. All historic episodes since 1994 have coincided with rising US Treasury and global government bond yields (see Chart 9). Similar to the US, the belly of the curve underperforms during periods of rising interest rates. In 1 % of the bear market episodes, yields in the belly rose more than in the wings (see Chart 1). Contrary to the US, even Bunds with up to 3 years maturity suffered negative absolute returns during bear markets on average. Only in 2 out of 1 observations was the short-end performance positive. 9

10 Duration Risk: Anatomy of (modern) bond bear markets Chart 8: German Bunds Evolution of yields during Bund bear markets average change (%) days (t = : start of 1 German Bund bear market episodes since 1994) German Bundyields (>1 year) +1 standard deviation 1 standard deviation Chart 9: US Treasuries Evolution during Bund bear markets average change (%) days (t = : start of 1 German Bund bear market episodes since 1994) US Treasury yield (>1 year) +1 standard deviation 1 standard deviation Chart 1: German Bunds Yield increase during Bund bear markets basis points maturity (years) Average rise of interest rates during 1 German Bund bear market episodes (since 1994) 1

11 US bond bear markets Consequences for other asset classes Historically, several asset classes have been able to withstand the negative impact of significantly rising government bond yields. On average, commodities have recorded the best performance during US bond bear markets (positive in 92 % of all observations), Global equities (1 %), US equities (85 %), US high yield (77 %) and US money market (1 %) also yielded positive returns (see Charts 11 and 12). With regard to other bond market segments, spread products tend to outperform US Treasuries during bear markets. Though absolute returns have been negative on average, spread products, like investment-grade (IG) corporate bonds, recorded declining spreads when compared to government bonds. Inflation-linked bonds do not offer a universal hedge against rising interest rates, as they protect investors only against rising inflation (expectations), not rising real rates. While the mean return of Treasury Inflation Protected Securities (TIPS) during US bear markets has been in the red, breakeven inflation rates rose during all episodes. Chart 11: US bond bear markets Return of other asset classes 2 Commodities Global equities (USD unhedged) US equities Return for all asset classes based on 13 bear market episodes since 1987, except for global equities (12), global government bonds (12) and US TIPS (1) US high yield 5.5 US money market 1.9 US TIPS US corporate bonds (IG) Global gov. bonds (USD unhedged) average performance during US bond bear market episodes (%) Source: Bloomberg, Datastream, Allianz GI Economics & Strategy, own calculation as of June 213. Chart: 12: Performance of US equities during bond bear markets average return (%) days (t = : start of 13 US Treasury bear market episodes since 1987) US equities (S&P 5) +1 standard deviation 1 standard deviation 11

12 Duration Risk: Anatomy of (modern) bond bear markets Bond bear markets in the Eurozone (Germany) Consequences for other asset classes The picture in the Eurozone (Germany) is quite the same as in the US. Commodities (positive in 9 % of all observations), German equities (9 %), global equities (1 %), Euro high yield (89 %) and Euro / Deutsche Mark (EUR / DEM) money market (1 %) were able to record positive absolute average returns during German bond bear markets (see Chart 13 and 14). Other EUR bond market segments have a strong tendency to outperform Bunds during periods of rising yields. Corporate bond spreads, for example, declined during all bear market episodes under review. 3 Return for money market, global equities, German equities and commodities based on 1 bear market episodes since 1994; all others based on 9 episodes. Chart 13: German bond bear markets Return of other asset classes 3 Commodities (EUR/DEM unhedged) German equities (DAX) Global equities (EUR unhedged) Euro High Yield 6.4 EUR/DEM money market 1.2 Euro corporate bonds (IG) French inflation linked bonds Global gov. bonds (EUR/DEM unhedged) Average performance during German Bund bond bear market episodes (%) Source: Bloomberg, Datastream, Allianz GI Economics & Strategy, own calculation as of June 213. Chart 14: Performance of German equities during bond bear markets average return (%) days (t = : start of 1 German Bund bear market episodes since 1994) German equities (DAX) +1 standard deviation 1 standard deviation 12

13 Bond bear markets and monetary policy Contrary to market wisdom, higher central bank rates are not a precondition for triggering a bond bear market. While several US Treasury bear market episodes coincided with rising US Federal Reserve (Fed) funds target rates (e. g. 1987, 1993 / 94), there were other observations in which central bank rates fell at the beginning (1998) or over the course (21) of the bear market (see Chart 15). Government bond markets tend to anticipate negative effects of rising central bank rates. In terms of performance, a lot of damage has already been done by the time central banks start to hike rates. Hence, bond investors must closely monitor any signs of a forthcoming change in monetary policy. Can analysts truly anticipate bond bear markets? As already shown in previous reports, analysts are usually unskilled at forecasting bond markets. Consensus expectations show strong pro-cyclical behaviour. Interest rate forecasts by analysts tend to fall prior to the onset of bond bear markets and start to rise 1 2 months after the turnaround. With respect to 1-year yield forecasts (on a 12-month horizon), consensus forecasts for US Treasuries (Bunds) fell in 92 % (8 %) of all observations in the 3 months before the start of a bear market (see Charts 17 and 18). At the current juncture, ongoing talk about Fed tapering might be enough to sustain a rise of US Treasury yields, even with rate hikes not being on the agenda. Chart 15: US bond bear markets and monetary policy average change (%) days (t = : start of 13 US Treasury bear market episodes since 1987) FED funds target rate +1 standard deviation 1 standard deviation 13

14 Duration Risk: Anatomy of (modern) bond bear markets Chart 16: German bond bear markets and monetary policy average change (%) days (t = : start of 1 German Bund bear market episodes since 1994) EZB main refi rate (BuBa discount rate pre 1999) +1 standard deviation 1 standard deviation Chart 17: US bond bear markets Consensus yield forecasts average change (%) months (t = : start of 12 US Treasury bear market episodes since 1993) US 3m T-Bill rate (consensus forecast, 3m horizon) US 1 y T-Note yield (consensus forecast, 3m horizon) Source: Bloomberg, Consensus Economics, Allianz GI Economics & Strategy, own calculation as of June 213. Forecasts are not a reliable indicator of future results. Chart 18: German bond bear markets Consensus yield forecasts average change (%) months (t = : start of 1 German Bund bear markets since 1994) German 3m rate (consensus forecast, 3m horizon) German 1 y Bund yield (consensus forecast, 3m horizon) Source: Bloomberg, Consensus Economics, Allianz GI Economics & Strategy, own calculation as of June 213. Forecasts are not a reliable indicator of future results. 14

15 Economic environment during US bond bear markets Macroeconomic data tend to deteriorate ahead of US bond bear markets and start to turn around when yields begin to rise. However, economic sentiment indicators lead bond market selloffs by around 1 month on average. Periods of rising bond yields normally coincide with an ongoing improvement of macro growth data. Our Macro Breadth Sentiment Index (see Chart 19), which measures the direction of the most important US economic sentiment and leading indicators, rose during 92 % of all bear market episodes. Unfortunately, economic surprise indices do not signal forthcoming turnarounds in government bond markets (see Chart 2). Martin Hochstein, CFA Senior Strategist Macro / Fixed Income Allianz Global Investors Chart 19: US Bond bear markets Macro Breadth Index average change months (t = : start of 12 US Treasury bear market episodes since 1993) US Marco Breadth Index (sentiment) +1 standard deviation 1 standard deviation Past performance is not a reliable indicator of future results Chart 2: US bond bear markets Economic surprises average change days (t = : start of 9 US Treasury bear market episodes since 21) US economic surprise index (growth) +1 standard deviation 1 standard deviation Source: Bloomberg, UBS, Allianz GI Economics & Strategy, own calculation as of June 213. Past performance is not a reliable indicator of future results 15

16 Duration Risk: Anatomy of (modern) bond bear markets Do you know the other publications of Capital Market Analysis? Risk. Management. Reward. Smart Risk investing in times of financial repression Managing Risk in a time of Deleveraging Active Management The New Zoology of Investment Risk Management Constant Proportion Portfolio Insurance (CPPI) Portfolio Health Check : Preparing for Financial Repression Financial Repression Shrinking mountains of debt International monetary policy in the era of financial repression: a paradigm shift Financial Repression and Regulation: Paradigm Shift for Insurance Companies & Institutions for Occupational Retirement Provision Silent Deleveraging or debt haircut? that is the question Financial Repression A silent way to reduce debt Financial Repression It is happening already EMU You can find our wide-ranging supply of publications on the euro on our site Eurozone Resource Center Bonds Emerging Market currencies are likely to appreciate in the coming years High Yield corporate bonds US High-Yield Bond Market Large, Liquid, Attractive Credit Spread Compensation for Default Corporate Bonds Why Asian Bonds? Dividends Dividend Strategies and Troughs in Earnings Revisions Dividend Stocks an attractive addition to a portfolio Dividend strategies in an environment of inflation and deflation High payout ratio = high earnings growth in the future Changing World Renewable Energies Investing against the climate change The green Kondratieff Crises: The Creative Power of Destruction Demography Pension Discount rates low on the reporting dates IFRS Accounting of Pension Obligations Demographic Turning Point (Part 1) Pension Systems in a Demographic Transition (Part 2) Demography as an Investment Opportunity (Part 3) Behavioral Finance Reining in Lack of Investor Discipline: The Ulysses Strategy Overcoming Investor Paralysis: Invest more tomorrow Outsmart yourself! Investors are only human too Two minds at work All our publications, analysis and studies can be found on the following webpage: 16

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