First the bad news: this week’s interest rate cut marks the end of the party for bond holders. Next, some mild consolation: another razzle is getting under way in the equities market, if you can just hang in.
‘I think it’s close to going home time. It’s been a long party,” Jonathan Myerson, bond analyst at Rand Merchant Bank, said this week.
Over the past five years bonds are estimated to have given returns of 20,4%, while equities delivered 14,3%. Myerson believes that the main driver of bonds has been an environment of declining inflation.
On Tuesday the R153, which matures in February 2010, closed at 8,89%, the lowest level in its 14-year history. When yields fall, prices go up. The R153 is widely regarded as the new benchmark for government bonds. This is because its sibling, the R150, now with a maturity date of less than 18 months, has effectively become comparable to many short-term financial markets instruments.
Other versions of popular bonds include the R194, maturing in 2008, and the R186, maturing in 2026.
One can think of a government bond as a company share, with South Africa as the company in question. One buys, in the first instance, because the country will not default on the stated coupon payment. Throughout its life the R153 has a coupon payment of 13%.
The second gain flows from the fact that if yields are driven sufficiently low the price will rise, so that the profit induces holders to sell before maturity. South African bond prices are denominated as a percentage of R1-million. The R153 was issued at R76%, or R760 000. It now stands at R120%, or R102-million.
Bonds are a crucial asset class alongside cash, equities and offshore holdings in a simplified portfolio.
Myerson describes cash as ‘a place to park your gains”. In times of high inflation and rising interest rates, one tends to take profit from shares and hold it in cash to benefit from high interest rates. When rates have peaked, it is time to get into bonds to ride the downward slide in yields and upward rise in price.
The reason one cannot make further gains now is that ‘the bond market is forward-looking,” as Myerson puts it. The market has already priced this year’s two remaining rate cuts and the expected fall in inflation.
He concludes by noting the yin and yang of the recent equities bear market. One of the biggest disappointments of the equity market was that it offered little protection from inflation.
The upside was that equities have been relatively cheap — which is why you should move across to them now.