Bull market in bonds not over just yet: Citi

The recent sharp rise in bond yields is a ‘head-fake’, according to Citi strategists.

Treasuries

The recent sharp rise in bond yields is a “head-fake”, according to Citi strategists, who don’t see bonds breaking out of the 35-year bull market and expect yields to stay low.

This view puts them starkly at odds with Credit Suisse, which last week released a note stating more or less the opposite.

The US 10-year government bond is yielding 1.61 per cent, still more than 26 basis points from its July 8 low of 1.35 per cent, despite cooling in recent sessions thanks to soothing words from the US Federal Reserve and Bank of Japan last week.

Australia’s 10-year yield has just drifted back below 2 per cent after rocketing 20 basis points in two weeks to hit a three-week high of 2.13 per cent on September 21.

Citi strategist Harvinder Sian said what we were seeing was not the end of the 35-year bull market in government bonds. Rather, the latest sell-off “reflected some disappointment with the recent ECB announcement to hold the line” on further rate cuts and changes to the quantitative easing.

However, Citi’s equity strategy does not paint such a confident picture, with analysts focusing on which stocks to avoid in an environment where yields continue to rally.

“Financials would benefit from rising bond yields,” said Citi’s global strategy team, led by Robert Buckland. “Banks in Europe and Japan have been especially helped by rising yields. Our colleagues also recommend avoiding expensive defensives such as telecoms in the US, pharma in Europe and Japan, utilities and REITs in Australia.”

Credit Suisse last week boldly stated that the Australian bond market was “erupting” and local stocks with high payout ratios and high price-to-earnings ratios were in danger of a correction.

In a comment that speaks directly to the division among analysts, Credit Suisse said: “Many have written off the most recent increase in bond yields as a blip in a longer-term downward trend”, but points to rising yields in US, Germany, Canada, Japan and Australia to argue that it signals a noticeable and ongoing reversal.

“The Australian equity market has benefited immensely from falling bond yields. But there has been a mini eruption in fixed-income markets over the last few weeks,” Credit Suisse strategist Hasan Tevfik said.

“If the bond market continues to erupt, and yields push higher still, we suggest investors tread with caution around those stocks at the very top of the ‘bondcano’.

“These stocks have high valuations, high ... leverage and high payout ratios. They will not like higher bond yields and include Sydney Airport, APA Group, Healthscope, Tatts and IAG. We add APA Group to our short portfolio.”

Credit Suisse said stocks best placed to withstand a continued rise in government bond yields include Qantas, Rio Tinto, Caltex and Macquarie Group.