The voices predicting a downturn in bonds are growing louder with Goldman Sach & Co.’s Abby Joseph Cohen adding hers to the mix at the Bloomberg Hedge Funds Summit on Wednesday, December 5.
Interest rates are historically low, leaving very little wiggle room if the Fed should decide to raise interest rates overnight.
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Despite the Fed’s announced commitment to keep interest rates low until at least 2015, there are factors that could force the Fed to raise rates sooner.
A solution to the fiscal cliff could improve the economy to the point where rates would need to go up and that equities will benefit from the reduced risk of uncertainty.
Jason Gottlieb of Visium Asset Management said the credit strategies that worked well this year were also highly leveraged. Hedge funds that use credit were given a similar dismal forecast as bonds.
Spreads are incredibly tight and Gottlieb feels it’s foolish to think they will continue. Cohen says stocks should outperform bonds as the economy recovers.
Long-only bond mutual funds have taken in $1 trillion since 2008. Investors have been fearful of equities and have poured money into higher risk bonds like junk bonds and high-yield emerging markets bond funds.
If the Fed does raise overnight bank rates, those holding bonds in their portfolios will only have about 15 basis points before the principal value of the bonds begins to negatively affect their portfolios.
In the 1980s when interest rates were at double digits, interest rates could move
as much as 2% to 4% before resulting in a loss of capital.
In today’s environment yields only have to rise by .15% to get losses in absolute terms over a one-year holding period.