Bonds can hold it all together in hard times

PUBLISHED : Sunday, 04 October, 1998, 12:00am
UPDATED : Sunday, 04 October, 1998, 12:00am


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CASH is king and bonds are beautiful, but equities face a difficult future - that's the message two of Indocam Asset Management's top analysts delivered last week.

Eric Taze-Bernard, Indocam's Paris-based head of strategy and asset allocation, described a world in which Japan's structural problems appeared to be deepening, Wall Street's valuations were over the top, and over-leveraging was prevalent - all of which was slowing growth and making deflation a real possibility.

It sounded dire. But not for bonds, Mr Taze-Bernard explained, because they thrived on just this sort of bad news.

'In this environment, bonds remain quite attractive. Lower rates, global slowdown, no inflation. This is a good picture for bonds,' he said. '[But] the landscape remains very difficult for equity markets in the short term.' Mr Taze-Bernard pointed to declining interest rates throughout the developed world - Europe, Japan and the United States - and forecast that bond yields would go even lower, with rates on bonds issued by core European governments dropping to 3.75 per cent and rates on US Treasury bonds to 4.5 per cent before year's end.

In the world of bonds, low interest rates are considered good because they go hand in hand with high bond prices. It is possible to get too much of a good thing, however.

Rates on developed-country bonds had fallen so low - and their prices relatively high - that Mr Taze-Bernard suggested looking elsewhere for lower-priced bonds that paid handsome yields. He found what he was looking for in emerging markets, where bond prices have come off dramatically and yields are up.

'The risk-return picture is quite favourable for emerging bonds. They are a very interesting asset class to look at,' he said.

Since mid-July, the JP Morgan composite index of emerging-market debt has slid 22 per cent, more than doubling the yield gap between these bonds and comparable Treasuries to nearly 12.3 percentage points.

Not all inexpensive bonds are good deals, of course. Just ask the ranks of investors who sank cash into junk bonds in the late '80s, only to retrieve mere cents on the dollar when the bottom fell out of the market a few years later.

Miron Mushkat, Indocam's Hong Kong-based director of economics and strategy, suggested a way around this problem: in Asia, invest only in US dollar-denominated sovereign and quasi-sovereign debt. Among good-quality quasi-sovereigns, he counted the Mass Transit Railway Corp and Singapore Telecommunications.

Mr Mushkat presented these as value plays in a region that offers few growth options. 'We continue to see the attractions of cash. There's little growth in Asia at present. Wherever we find growth we embrace it, but where cannot find growth, we are going to settle for value,' he said.