Analysis & Comment  > Bond of the Week

Share |
Back to 2013

Bond of the Week: 5 July 2013

Bond prices: Low enough?


The much-anticipated and highly influential US Nonfarm Payroll was released earlier today.  At 195,000, the number was better-than-expected. It immediately excited the equity bulls and sent stock prices to an upward march (link). But in this bullishness over unemployment, one casualty stands out: Bonds.

The US 30-year Treasury Future, updated just after the release of the jobs data, shows a decisive downtrend reassertion. It slumped nearly two points minutes after the data release, adding to the fourteen-point drop over the previous six weeks (see below). New long-term price lows are likely to bring more momentum sellers into the market. The orderly downtrend can easily turn riotous.

What next? Are current bond yields high enough to tempt investors?  Are there bargains to be had in the bond market?

No doubt, many well-informed readers are aware of the extended weakness in the ORB market over the past two months. The FTSEORB Index captures this state of affairs (see below). From a peak of 110.6, the index is currently trading beneath 104 - a decline of 5.8%. The severe decline in US bond prices today would probably hold it down further. (Note: I recommended some downside hedging in bonds two weeks ago.)

Drilling down to individual retail bonds, I notice that, compared to the pricing back in March, many bonds are now offering yields in excess of 6% (link). If the US yield curve continues to rise, these ORB yields would probably drift higher.

A quick check of the Sterling Yield Map show a few interesting issues. Enterprise Inns 6.5% 2018, recommended as a take profit/sell on 10 May 2013 here, is now offering investors a tempting yield of 7% once more.  The Provident Financial 7% 2020 offers a yield of 6.2% - not too bad considering the risk. The Provident Financial 7.5% 2016, with just three years to maturity, is offering a yield of 5.9%. In comparison, the three-year gilt yield gives investors a paltry yield of 0.6%!

So, should we dive straight in and mop up as many corporate bonds as possible? No!  

After years of market watching, I have developed a great respect for price momentum. A security/asset surfing on strong price momentum will override all other considerations. Valuations become hard to determine. Strength begets strength; weakness leads to further weakness. Think of the Nasdaq bubble – and its subsequent collapse.  

Given that bond yields are soaring in the US, I suspect it will drag most other government bond yields higher. The rally will also depress corporate bonds. Should I fight this trend? Well, not until the upward trend in yields loses momentum. Patience is needed whilst waiting for bargains to appear.   

View: The bond bears are having a field day after the release of the US job data. This weakens the already fragile US Treasury market. Amidst this frantic selling, I would be wary of ‘bottom fishing’ in the government bond market as the sector’s weakness could easily extend. That said, I suspect that the US central bank would not let this situation get out of hand. At some point in the future, the downtrend in government bond prices will slow and reverse. I stand ready to buy. But what would I buy? The first choice that springs to mind right now is short-maturity, high-yielding corporate bonds. An example is the unrated Provident Financial 7.5% 2016, which offers 530bps above gilts.  Another choice is Places For People 5% 2016, whose yield of 3.56% is a full 290bps above the 3-year gilt yield.  The shorter maturities on these securities limit the duration risk. I would only look to buy long-maturity corporate bonds when the government bond yields lose their upward momentum.  

Dr Jackson Wong

Disclaimer is a division of Stockcube Research Ltd which is authorised and regulated by the Financial Services Authority. The research provided by Stockcube on the Website (and any other Stockcube website) is provided solely to enable investors to make their own investment decisions and does not constitute personal investment recommendations. No recommendations are made directly or indirectly by Stockcube as to the merits or suitability of any investment decision or transaction which may result directly or indirectly from having viewed the investment research on the Website or having received it by email. Investors are therefore urged to seek independent financial advice if they are in any doubt. The value of investments and the income derived from them can go down as well as up, and the investor may not get back the full amount originally invested.

Bonds, as with all investments, are subject to price volatility and in the event of a default an investor may lose some or all of his or her original investment. This site also contains references to derivatives. These are particularly high risk, high reward investment instruments and an investor may lose more than his initial margin requirement. Some foreign currency instruments are also featured and if an investor decides to acquire any investment denominated in a currency different from the his or her own,  the investor should note that changes in foreign exchange rates may have an adverse effect on the value, price and income of the investment in the base currency.

None of the services provided as a result of this agreement constitutes a personal recommendation to invest from Stockcube and no service should be construed as such.  For the avoidance of doubt, where the word “recommendation” is used elsewhere in these terms it does not refer to a personal recommendation, unless this is explicitly stated.  The investments described by or in the services are not suitable for all investors. Investors  who have any doubt about whether particular investments are suitable for them should contact an independent financial adviser.

These services do not include personal investment recommendations from Stockcube and should not be construed as such. Stockcube may, at its discretion, provide information, advice, recommendations and research to subscribers from time to time on its own initiative or advise subscribers of other services available. Stockcube will be under no obligation to provide on-going advice in relation to financial instruments covered on this website.