U.S bonds are in a bear market that started in July 2016 when the 10-year Treasury note “double-bottomed at 1.45%,” says Bill Gross, the Pimco co-founder who’s now a portfolio manager for the Global Unconstrained Bond and Total Return strategies at Janus Henderson.
The July bottoms signified the end of a bull market that began 35 years earlier, but they weren’t recognized as such at the time, notes Gross in his latest market outlook.
“Eighteen months ago, it was obvious to most observers that the economy, measured by nominal GDP, was not going to go much lower than 3% and that the Fed was having second thoughts about quantitative easing,” but the bond market wasn’t priced for that, writes Gross. It was priced instead for “perpetual QE and the possibility of a deflationary collapse in the economy” — neither of which happened.
What happened instead was the 10-year Treasury yield plateauing between 2% and 2.25% for several years and high-yield bond prices rising enough to help index portfolios holding some return around 5% in 2017, which soothed bond investors, writes Gross.
But those days are over, according to Gross. “That 5% number may be hard to duplicate. High-yield spreads are compressed and not likely to provide future capital gains and the situation in Treasuries [yielding 2.55% at the time of his writing] is not conducive to a ‘total return’ environment.”
Gross expects the 10-year Treasury will end this year with a yield above 2.7%, capping a “mild bear market total return of zero to -1% for most bond portfolios.”