After 1994's pathetic year, debate rages in the global bond markets over where investment opportunity for 1995 lies. Should compasses be steering toward North America, or will Europe finally pull through?
This divergence comes as investors foresee an overall tepid year ahead. No markets really look hot. But compared with 1994's showing, many foresee global bonds this year faring better.
In 1994, the Salomon Brothers World Government Bond Index in local currency terms fell 3.27%. (But because of weakness in the U.S. dollar, the Salomon WGBI rose 2.34% for American investors.)
The new year brought renewed declines, partly in the wake of the Mexican market fiascos, political uncertainties in Europe and expectations of more tightening of monetary policy by the Federal Reserve Board.
Now, investors are considering two main hopeful factors: high real rates in Europe that could attract buyers and expectations that U.S. interest rates will peak sometime this year and be followed by a bond rally.
Arguments are compelling on both sides. But little seems certain, especially because some think the peak in U.S. rates might not come until later this year. In Europe, many investors still are wary of such problems as political upheavals and scandals in Spain and Italy, the coming elections in France, the downgrading of Sweden's debt and the possibility of credit tightening by Germany's central bank.
Still, some brave investors are forging ahead. At a mid-January strategy meeting, Kemper Investment Management Co., London, decided to lift its European weighting for global bonds to 60% from a level in the mid-50s. The firm wanted to take advantage of the recently higher yields in European bonds, said Gordon Johns, managing director. Kemper favors the bond markets of France, Finland, the Netherlands and Ireland.
Other managers like German bonds, where they believe business and governmental policies are creating sound fiscal and monetary policies as well as economic growth. London's Rogge Global Partners has 40% to 50% of its global bond portfolio in German bonds because of confidence in the government's "ability to deliver steady economic growth and further reduce deficit spending," said partner Olaf Rogge. While real yields in Germany aren't as high as other parts of the Continent, Mr. Rogge believes that, over the next 12 months, public confidence in Germany will grow. In turn, that should bring more interest in buying German bonds.
Although cautious on bonds overall, at least for the first quarter, Paul Burik, chief investment officer of Commerz International Capital Management GmbH, Frankfurt, Germany, is overweighted in Europe. To be sure, the firm is holding shorter maturities - and rates aren't expected to decline soon in Europe. But on the brighter side, Mr. Burik sees the "prospects for stability." Within Germany, he said, inflation appears under control, "GDP growth is not accelerating beyond levels observed in 1994 and prospects (appear good) that the government will be able to keep the fiscal situation under control."
Mr. Burik acknowledges German rates rose early this year - partly as a spillover from rate rises in problem markets. But he anticipates rates could come down again faster in Germany than in some of the other European markets.
However, another contingent of investors has a different view. This camp favors North America and the so-called "dollar bloc" on the expectation that U.S. interest rates, which rose earlier than those in Europe, will be earlier to fall. Moreover, some markets - such as Australia - offer temptingly high yields.
Dick Howard, economic research director of Julius Baer Investment Management, London, expects U.S. bonds to become attractive by midyear. And he has "penciled in a modest rally in the U.S. market" -as well as a "modest bear market in Germany."
In the favored "dollar bloc," he also cites Australia and Canada. In late 1994, the firm moved to capture the "outstanding opportunities in Australia," where the 10-year bond has a real yield of about 8.7%, he said.
In his view, Canada's market could become a buying opportunity soon. Although many in the marketplace are wondering how aggressively Canada will move to cut its budget deficit - especially because of domestic political pressures to expand social spending - Mr. Howard believes Canada will continue to attack it.
For global bonds, Los Angeles' Payden & Rygel now has nearly 60% in the United States, compared with a 1994 low of 20%. "We think that the U.S. is closer to an interest rate peak than some countries in Europe," said John Isaacson, executive vice president.
Conversely, he believes that because Europe's economic renewal is about where the United States was last year, "there could be more rate hikes" in Europe. In the fourth quarter, the firm became overweighted in the United States, taking money out of Europe in particular and also Japan. Payden & Rygel also has some exposure to Canada and Australia. In maturities, it has reversed course from last year by lengthening U.S. maturities and shortening bond maturities in Europe.
For now, Bridgewater Associates, Wilton, Conn., is "modestly bearish on global bonds, particularly those of the U.S., Germany and Japan," said President Raymond Dalio. In turn, the firm likes the markets of Australia, Italy and France, where rate increases have become excessive, in Mr. Dalio's view. The three favored markets comprise just less than 50% of Bridgewater's global bond portfolios. But by the end of the year, Mr. Dalio said, rates could head lower.
But, underscoring the current divergence in views, Bailard, Biehl & Kaiser, San Mateo, Calif., is bullish on the next 12 months. While a sustained rally isn't expected soon, one could come "in the March-April period with signs of economic growth slowing and inflation contained," said Arthur Micheletti, chief economist. He believes today's high yielding markets are "pricing in too much inflation."
His firm has 35% of global balanced portfolios in bonds -and is overweighted in non-U.S. markets. The firm has another 5% in cash earmarked for global bonds. The firm will decide in about another month whether to put the money into U.S. or foreign bonds. But according to Mr. Micheletti, current conditions "argue for international, because yields are higher in Europe" than in the United States.
