Bond bull markets: lessons from the past

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The conditions for the largest bond bull market in modern history were set in the 1970s, when inflation reached runaway levels. Central banks, led by the US Federal Reserve, launched a draconian response, sending interest rates through the roof. Over the 40 deflationary years to the end of 2021, the annualized real bond return in the world bond index was 6.3%, not far off from the 7.4% return on world stocks over the same period. So says Credit Suisse's invaluable Global Investment Performance Yearbook prepared by economists Elroy Dimson, Paul Marsh and Mike Staunton. As today's central bankers doggedly pursue so-called "higher for longer" interest rate policies, many investors have bet, so far without reward, on history repeating itself. However, it is important to note that the equity-like returns on government bonds in this golden period were a mixed blessing for investors.

Furthermore, this spectacular 40-year streak created a new mythology of bond investing, along with a perversely misleading vocabulary. Academic economists and actuarial consultants declared that government bonds Job Function Email Database were “safe” assets that generated a risk-free interest rate. They also claimed that bonds offered diversification versus risky stocks, an argument that provided the justification for the hallowed 60/40 portfolio split between stocks and bonds. But in much of the developed world, the yield on many government bonds before 2022 was negative in both nominal and real terms, which is a curious kind of risk-free rate. These bonds offered investors the certainty of a guaranteed loss at maturity. On the safety front, global bonds offered a real return in 2022 of less than 27 per cent, and UK gilts performed even worse than that.



The reality is that nothing in the capital markets is risk-free. This collision of myth with reality has serious implications not only for governments and regulators. It affects individual investors, who are contemplating how they should respond to the new bond landscape; UK fixed-term mortgage borrowers, whose mortgage lending rates are heavily influenced by the trajectory of gilt yields; and pension savers looking to reduce volatility in their pension investments as they approach retirement. The illusion of protection Paradoxically, investors in longer-term index-linked bonds last year saw their investment decline by a third or more in value on a market basis. Many bought under the mistaken assumption that they were purchasing protection against rising inflation. However, the protection only operates if the indexed bond is held until maturity.