It's Asian bonds, not equities, that are too rich

Thu Jun 26, 2014 5:19am EDT
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By Vidya Ranganathan

SINGAPORE (Reuters) - An unusual parallel rally in Asian bonds and equities, powered for the last five years by cheap global funds, could give out soon with debt becoming a casualty of the increasing confidence in the outlook for global growth.

Bonds are now pricing in an extremely bleak economic outlook, making them susceptible to any spike in long-term rates. The rise in equities has been less pronounced, leaving room for further gains as a pick up in global demand boosts corporate earnings.

The tricky part for investors, however, is to precisely time their exit from bonds. Strictly speaking, bonds can continue to feed off the supply of cheap money from central banks in developed markets. Plus, there is the nagging risk of a hard landing in China and escalating crises in Iraq and Ukraine, which could push investors back into the safety of fixed-income assets.

"It's a bubble in caution," said Markus Rosgen, Asian equity strategist at Citi.

"The bond market is too bearish on the outlook for growth, and people will say if growth is improving, then I have a claim on growth through equities which I don't through bonds, then I ought to switch out of bonds into equities."

"So it's generally equity-friendlier than it is bond-friendlier," said Rosgen.

Investment bank analysts warn bond levels are frothy and there are traces of a shift of retail money from bond funds to equity. But the actual decision to sell bonds is complicated by powerful but divergent catalysts.

The Federal Reserve is reducing its bond purchases, but appears in no rush to raise interest rates. European authorities are easing policy. Britain has hinted at early rate rises. A handful of Asian central banks, including in New Zealand and the Philippines, are raising rates.   Continued...

An employee counts Chinese 100 yuan banknotes at a branch of China Merchants Bank in Hefei, Anhui province June 21, 2013. REUTERS/Stringer