By Palash R. Ghosh: Subscribe to Palash's RSS feed
November 30, 2010 6:59 PM EST
As investors continue to shovel mountains of cash into U.S. Treasuries and U.S. bonds, investors seeking yield and price outperformance are advised to look at bonds issued by the emerging markets nations.
Since early April (in tandem with revelations of Greece’s debt crisis) bond yields in the U.S. have steadily fallen – the yield on the benchmark 10-Year Treasury has plunged from about 3.99 percent on April 5 to 2.82 percent as of yesterday’s close (although the yield has been rising since hitting a low of 2.38 percent in early October).
Falling bond yields continue to reflect a disdain (perhaps even fear) of stocks, despite the fact that the economy appears to be stabilizing and equities have delivered gains so far this year (and have rallied superbly from March 2009 lows).
Indeed, year-to-date through the end of September, almost $30-billion have flowed out of U.S. equity funds, while taxable bond funds have been enriched by $213-billion, according to the most recent data from the Investment Company Institute (ICI).
Milton Ezrati, senior economist and market strategist at Lord Abbett, pointed out that with the 10-year Treasury yielding below 3 percent, that barely compensates holders for inflation after taking their tax liabilities into consideration.
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“U.S. bonds are definitely at or near a bubble,” said Rob Russell, president of Russell & Co. in Dayton, Ohio.
“And that bubble will pop as soon as we see any signs of inflation and the Fed is forced to hike interest rates. That action will destroy bond values, especially for those securities with intermediate to long-term maturities.”
Russell recommends that investors re-allocate some of their assets to emerging market sovereign bonds, which he believes, are poised for further growth.
Bond yields across the emerging markets currently average about 6 percent.
“That is where the value is right now, in the developing world,” he noted. “The risks are that they’re not as safe as U.S. bonds and their credit quality is not quite as good -- but that’s why you get much higher yields.”
Ezrati noted that while “investors clearly have remained fearful of equities, they have nonetheless shown little fear of the once-risky world of emerging sovereign debt.”
In fact, net flows into emerging market bond funds have amounted to nearly $40-billion through the first nine months of the year, according to EPFR Global.
As money has poured into emerging markets bonds, Ezrati indicates, these purchases “have, in fact, driven up the prices in this area even faster than the prices on U.S. Treasury and agency debt, so that yield spreads over U.S. Treasuries, according to the JPMorgan Emerging Market Bond Index (EMBI+), have collapsed by more than 500 basis points so far this year.”
While Russell concedes that prices of emerging markets bonds have indeed risen this year, they still make a good buy because they much room to further appreciate.
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