Despite a roaring U.S. stock market, investors continue to pile money into the bond market at a record pace.
Last week, in fact, set a new standard for cash flowing into fixed income funds with $23.6 billion of inflows, according to Bank of America Global Research. If that keeps up, the year will see another $1 trillion of inflows for the $10 trillion already in global bond market funds. By contrast, equity funds took in a net $8 billion in 2019.
BofA’s chief investment strategist Michael Hartnett said the market is seeing a “twin” bubble of assets coming into both bonds and tech stocks.
However, investors are betting that a low interest rate environment coupled with slow though not spectacular economic growth will make bonds both a way to preserve capital and generate income at a time of growing volatility in the stock market.
“We’re seeing a rising tide lift all boats right now,” said Bill Merz, fixed income strategist at U.S. Bank Wealth Management. “There’s a bit of a rebalance trade there. But I think the underlying catalyst is just this remarkable degree of liquidity coming from the major central banks in the last few months that have kept this going.”
Indeed, after efforts by central banks to get back into a more pre-financial crisis policy lane scared markets, the Federal Reserve and its global counterparts have turned on the monetary spigots again.
By Merz’s count, central banks have added about $800 billion worth of liquidity since the September tumult in overnight lending markets, in the form of bond purchases aimed at stabilizing repo operations and, in some cases globally, to spur growth. Money has been looking for a place to go, and much of it has funneled into a bond market that has seen yields across both government and corporate debt test all-time lows.
Low rates far as the eye can see
Since the collapse of Lehman Brothers during the financial crisis, central banks have cut rates 800 times, Harnett said.
That’s made for an appetizing environment for fixed income. As an asset class, bonds have underperformed stocks, but the steady returns make them a buffer against volatility. As yields have fallen lower, prices have risen, providing principal gains for bond holders.
“What we’re seeing is that valuations are relatively high. But they can stay high for some time,” Merz said. “People shouldn’t be expecting 2019 returns out of the bond market.”
U.S. Bank is steering investors away from parts of the market, particularly bank loans, and overall is underweight bonds and favoring equities.
But even with tempered returns, investors are likely to continue to come to bonds even as areas like high yield and bank loans appear dangerous, particularly if rates start to rise.
The advantages of fixed income remain attractive, particularly for aging investors.
“I’m not so concerned about what happens when interest rates go up. Investors will lose money on these investment products, but it’s going to take a very long time for people’s faith in bonds to be shaken,” said Mitchell Goldberg, president of ClientFirst Strategy. “I don’t really sense that it’s economic news that’s driving a lot of investors towards bonds. I think most of it is age-based allocation shifts.”
Goldberg said his main worry is about investors chasing yield and end up buying things with rate risk. But he sees those kinds of dangers decreasing since the debt market imploded during the crisis.
“There’s a lot of recency bias in this, too. Anytime anyone has waited for higher interest rates, they’ve been burned because rates keep going lower,” he said. “Now it looks like retail investors have finally caved. They are just going for it as far as getting into fixed income products.”