RPT-GLOBAL MARKETS WEEKAHEAD-Debt concerns spoil holiday cheer

(Repeats Friday’s story without changes)

By Natsuko Waki

LONDON, Dec 17 (BestGrowthStock) – Investors get down to the final
weeks of a year that has seen healthy gains on risky assets with
a nagging feeling that a reasonable growth profile next year
would trigger an even more drastic sell-off in government bonds.

U.S. Treasuries have been sold off, pushing yields to a
seven-month high, after President Barack Obama reached a deal to
extend tax cuts, sparking concerns over a widening budget gap
while also boosting hopes for U.S. economic growth.

This comes as world stocks, as measured by MSCI
(.MIWD00000PUS: ) raced towards a two-year high, bringing this
year’s gains to nearly 9 percent.

In the week to Dec. 10, bond funds saw a weekly outflow of
$0.9 billion on a four-week average, according to JP Morgan,
while equities drew an average flow of $2.6 billion.

The euro zone debt crisis is far from over, with Friday’s
deep downgrade of Ireland’s sovereign ratings fanning fresh
concerns. But the risk is for a wider contagion.

“There is a risk that the sovereign crisis will spread
across the Atlantic to the U.S. … There’s already evidence
that it’s turning to disorderly unwinding,” said David Woo, head
of global rates and currencies at Bank of America Merrill Lynch.

“There are clearly very uncomfortable positions in the
market that will be unwound, especially if data holds up. There
is a 30 percent chance of a serious turmoil in the bond market.”

Woo expects 10-year Treasury yields to rise to 4 percent by
the end of 2011.

A shift out of government bonds to equities in itself is not
a worrying phenomenon, with investors who have a bigger risk
tolerance chasing higher-yielding assets.

But a resulting spike in yields pushes up long-term
borrowing costs, which weigh on the ability of corporates and
governments to finance themselves.

Benchmark 10-year U.S. Treasury yields rose above 3.5
percent (US10YT=RR: ) in the past week, their highest since May.

“Investors have been crying wolf about government bonds for
two years: maybe the wolf has now arrived, just as everyone has
learned to ignore the warnings,” noted Max King, strategist at
Investec Asset Management.

“If bond investors switch from complacency to paranoia,
10-year yields … could rise much further. Higher yields would,
in turn, further undermine sovereign credibility, shutting all
but the best quality borrowers out of the market.”

JP Morgan says there is a strong relationship between past
bond returns and mutual fund flows.

Historically, bond fund flows turn negative when the
12-month return on the Barclays U.S. Aggregate Bond Index — an
industry benchmark — falls below 6 percent.

JP Morgan expects the 12-month return to fall to 6 percent
in the second quarter, then reach 3 percent by the end of 2011.

CONSENSUS TRADE

Against this backdrop of favouring equities, the Volatility
Index, a barometer of investor anxiety, has fallen to
eight-month lows below 17 percent (.VIX: ), approaching levels
seen before the start of the credit crisis in 2007.

As many as 92 percent of fund managers polled by the
Association of Investment Companies thought equities will rise
in 2011 while 80 percent of them thought equities will be the
best performing asset next year.

An overwhelming preference for equities among asset managers
does raise a risk it is becoming too much of a consensus trade.

“Investors will be surprised by the ability of
financially-strong, well-managed blue chips to grow sales and
profits, even in an anaemic growth environment,” said Andrew
Bell, chief executive officer of Witan Investment Trust, which
took part in the AIC poll.

“However, the variable growth backdrop will not be enough to
re-float all boats so an emphasis on quality is called for.”

Morgan Stanley’s analysis based on 15 years of data shows
equities rise until government bond yields approach the level of
nominal GDP growth, at which point yields would effectively no
longer be negative and would be less supportive for risk assets.

The bank expects nominal U.S. GDP growth of 4.5-5 percent in
2011. This leaves about 1.6 percentage points of yield upside
for equity investors before they start turning cautious.
(Editing by Catherine Evans)

RPT-GLOBAL MARKETS WEEKAHEAD-Debt concerns spoil holiday cheer