There is still a case for maintaining a long-term exposure to fixed income in your portfolio, according to John Pattullo of the Janus Henderson Strategic Bond fund, who says stubbornly low inflation will continue to confound the bond bears for years to come.
The yield on 10-year Treasuries reached a four-year high on Monday at 2.9 per cent on the back of higher-than-expected inflation, which some analysts have taken as the latest sign we are approaching the end of the bond bull market.
However, Pattullo pointed to a chart showing that in 24 of the last 26 years, the fixed income community as a whole has predicted the wrong direction for Treasury yields. He said this is something investors should bear in mind whenever they hear talk of a prolonged downturn in the sector.
“That is complete claptrap,” he said. “What is true is that this long-term channel is testing, for maybe a day, a week, or even a month going forwards, and that doesn’t mean it will suddenly turn into a massive bear market.
“The US 10-year Treasury has bottomed twice, in the summer of 2012 and the summer of 2016 and has a four-year bottoming pattern at 1.3 per cent. The top of the channel is 3 per cent, and I suggest it is going to be rangebound between these two figures for the next five or 10 years.
“That is a very important point – whereas if you read some of the talk in the press, it is going to go up forever.”
Pattullo (pictured) said bond yields will only go far above this range if there is a prolonged period of inflation. The manager is sceptical this will materialise – he pointed to the case of Japan which has been in the grip of deflationary forces for 30 or so years and said this is what the western world has to look forward to.
“Japan used to rule the world in the 1980s,” he continued. “It had the biggest banks, the best technology, its equity market was on fire and this was all built on leverage – you know the story.
“But they had their financial crisis and people changed behaviours due to the amount of debt they had. The trauma and the experience of having negative equity meant they changed their consumption patterns – that’s true of the individuals and it’s true of the corporates as well.
“Lowering interest rates doesn’t do anything whatsoever, because people don’t want to borrow money – they just want to pay off their mortgage.”
Pattullo said Richard C Koo’s book The Holy Grail of Macroeconomics, which focuses on Japan’s recession, completely changed his thinking on bond markets and the way people behave. It also helped him understand the growth slowdown in US household debt following the financial crisis.
Aside from the aftermath of its financial crisis, Pattullo said there are other deflationary forces acting in Japan. For example, he noted that the fertility rate is 600,000 per year, down from 2.7 million at its peak and the replacement ratio is one of the lowest in the world at 1.44. As a result, the population of 128 million is forecast to drop to 88 million in 2065.
“It’s extraordinary,” Pattullo continued. “Forty per cent of people aged 18 to 34 are virgins.”
However, the manager said this wasn’t even the most frightening statistic.
“There are 8 million empty houses in Japan and by 2030 there will be 20 million, a third of the housing stock and I would suggest that is massively deflationary.”
“And the demographics in the West are going to follow Japan. The average age of people in Japan is 47, versus 42 in the UK. Peak spending is at 46. By 2050, 50 per cent of the population in Japan isn’t going to be working and the demographics of the UK, China and the US will follow.”
In a recent article on Trustnet, global economist at LGIM James Carrick highlighted the same problem.
He pointed out that whereas the biggest age group in western Europe in 1980 was 15- to 19-year-olds, today it is those around the age of 50 – meaning people who are still working, but approaching retirement. It is forecast that in 2050 there will be similar numbers in each age group.
“A population pyramid is where lots of young people are at the bottom and there are a few old people at the top. I think we’re moving towards a population skyscraper – it is vertical and we’ll have the same number of old and young people,” said Carrick.
It is not just that the population is getting older, but the consumption habits of the youth are changing as well. Patullo said Millennials – or the “Avocado on Toast generation” – approach spending, saving and investing in a completely different way from the baby-boomers.
“We’ve all been aware of the baby-boom boom washing through society,” he continued. “Millennials are more of a wavelet, so smaller in number and more cautious. They grew up with the global financial crisis and global terrorism and a lot of them have a lot of student debt.
“They don’t have the same need, want or ability to buy or consume that our generation did. They would much rather take an Uber than buy a car. When they go on holiday, they take Airbnb. They have very different dynamics and in my opinion they will consume a lot less, which is another reason why we don’t think inflation is coming back.”
Data from FE Analytics shows that the Janus Henderson Strategic Bond fund has made 167.53 per cent since Pattullo became manager in October 1999, compared with 138.3 per cent from the IA Sterling Strategic Bond sector.
Performance of fund vs sector under manager tenure
Source: FE Analytics
The £2bn fund is yielding 3.3 per cent and has ongoing charges of 0.69 per cent.