The Next Bull Market In Bonds Starts Now

Austin Hatley's picture

Tuesday, June 24, 2014 - 10:15am

by Austin Hatley

1982 was a great year to become a U.S. bond investor.

At the time, energy prices were high and the economy was in shambles. To make matters worse, the U.S. adopted a tight monetary policy due to high inflation in the 1970s.

The outlook for bonds was bleak. Yields were at all-time highs and prices were at historic lows. At one point the 10-year treasury yielded north of 14%.

While no one realized it at the time, this was the starting point for the biggest bull market in bonds the world has ever known...

Thanks to easing monetary policy, over the next 30 years U.S. treasuries would go on to return 246% in capital gains. Add in the 14% yield that investors would have received over that time, and the total return for government bonds from 1982 to 2012 was 667%.

That translates to an annual return of 22%... and that's from boring, safe bonds, mind you. To give you an idea of how incredible that is, hedge funds generally target a return of 11-12% a year.

Unfortunately, as we told in you a previous StreetAuthority Daily issue, the opportunity in U.S. debt has long since evaporated. The Federal Reserve has used its printing press to push prices to all time highs. Buying bonds now would be suicide. They simply have nowhere to go but down.

But it's a different story in emerging markets. In fact, right now these countries could be setting up the biggest bond trade since 1982. And like back then, conditions are ripe for incredible returns.

Here's what you need to know...

According to a research report by Goldman Sachs, emerging-market economies will grow from just $2 trillion in 2012 to $80 trillion by 2040. They go on to predict that emerging markets will account for more than 75% of global economic growth over that time.

As emerging-market economies grow into global leaders, their credit ratings will improve. And as a result, they'll benefit from lower borrowing costs -- which should drive bond prices higher. What's more, given the state of emerging-market interest rates, there is a ton of upside in emerging-market debt right now.

The question, of course, is when should investors get in? And how?

StreetAuthority analyst Michael Vodicka answers that question in his June issue of High-Yield International. In his essay, he tells readers why he's growing increasingly bullish on emerging-market bonds...

While emerging market economies don't enjoy high credit scores, that may be changing quickly.

There are two powerful catalysts unfolding that remind me of what kicked off the epic Treasury rally in the early 1980s.

In the short run, emerging markets are moving out of a challenging period when they were forced to raise interest rates. Just like the Fed in the early 1980s, emerging markets were battling some pretty wicked inflation -- Argentina saw inflation spike to 27% in late 2013. Inflation in Turkey hit 10% in 2013. Onion prices in India jumped 300%. That's why Brazil, Turkey, Indonesia and Argentina all raised interest rates in 2013.

Those rate hikes are one of the reasons emerging market interest rates are still trading near multi-year highs. Brazil's Benchmark rate stands at 11%. Indonesia's is at 7.5%. Vietnam is at 6.5%. That leaves plenty of room for rates to drift lower in the long run. And that is creating a big opportunity for income investors.

Right now, with U.S. interest rates reversing and heading lower -- where I believe they will stay for a long time, just as with interest rates in Japan -- emerging market central banks have once again begun letting interest rates drift lower.

This is exactly what the Fed did in 1982 that triggered the long-term rally. And it's an important short-term catalyst for emerging market bonds that is already in play.

We're already seeing this trend play out in the bond market. Since the beginning of the year, the iShares JPMorgan USD Emerging Markets Bond (NYSE: EMB) ETF has outperformed its sister U.S. bond fund, iShares Investment Grade Corporate Bond (NYSE: LQD) ETF, while also carrying a higher yield.

But Michael thinks this rally may just be getting started. As he goes on to say...

That short-term momentum in emerging market bonds is still very much in play as U.S. interest rates continue to drift lower. And even if U.S. interest rates do eventually head higher, emerging markets may still see their credit scores jump sharply due to economic growth.

Just like the United States experienced a massive economic boom beginning in 1982 that sent Treasury prices soaring -- emerging markets are in position to repeat the same cycle...

As emerging markets grow faster than developed economies in the next 20 years and comprise a larger portion of the global economy, many more will likely be upgraded to investment grade. And as that happens, interest rates will fall and investors who own these bonds could see big capital gains -- while also locking in an outsized yield on the front end of the long-term cycle -- yields trading at more than a 200% premium to the yield on U.S. Treasuries.

Now out of fairness to High-Yield International subscribers, I can't show you exactly how Michael and his readers are investing in this trend. But one thing is clear: Emerging-market bonds are on the cusp of a bullish cycle -- similar to the one U.S. Treasury Bonds experienced from 1982 to 2012. If history is any indicator, then there's a big opportunity for investors in emerging-market debt.

P.S. -- By now you know that many of the best high-yield opportunities are found outside U.S. borders. In fact, Michael Vodicka's latest research found more than 90 international stocks paying 12%-plus yields... and hundreds more paying yields above 6%. And many of the world's wealthiest investors -- including Warren Buffett -- have been quietly cashing in on them for decades. Get more details about these international high-yielders by visiting this link.

 

Austin Hatley does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.