Five years of global credit crises and lackadaisical global economic growth have had one good outcome: debt markets have been on a prolonged rally.
One might ask how much longer this rally will continue and whether it’s time to think about switching into equities.
The UBS CIO Wealth Management Research house view is clear on the point: there is more life in the Asian bond rally.
This discussion involves a slight technical detour. There are two basic components to bond pricing: the benchmark and the spread over the benchmark. For US dollar bonds, even those issued by Asian firms, the benchmark is almost always US Treasuries, or US government bonds.
The spread is a measure, in basis points, of how much a given bond pays in terms of yield over the benchmark. On these criteria, Asian bonds look well-positioned.
For example, thanks to continued interventions by US Federal Reserve chairman Ben Bernanke, we expect 10-year US Treasuries to yield just 1.7 per cent by the year’s end. This low yield will drive investors into other instruments, such as Asian bonds.
While US Treasury yields are at a historic low, Asian bonds pay a healthy spread over this benchmark. This means Asian bond prices have room to rise over the medium term.
In many ways, Asian companies are much better positioned now than they were prior to the liquidity crunch of the 2008-09 global credit crisis. They have more cash and less debt. Meanwhile, a prolonged fixed-income bull market has meant lots of liquidity in this market – it is easy to sell bonds at a fair price.
Track record is also important. For example, during the credit crisis, Chinese property developers and Indonesian coal issuers could only issue bonds at high coupons. The issuers’ ability to subsequently pay these coupons with no defaults has meant investors have profited handsomely from the deals, lifting expectations about Asian debt.
Asian bond prices will also get a lift from a continued flow of capital from developed market funds into the region. Not only that, Asia has in its favour a succession of positive ratings upgrades, including sovereign upgrades for Indonesia, South Korea and the Philippines.
This stands in marked contrast to the downgrades and generally soggy economic outlook seen in the euro zone and the United States, which is why the money will keep flowing to Asian debt markets.
Carl Berrisford is an analyst with UBS CIO Wealth Management Research