OECD Data Signaled Bond Outperformance: Gave

The recent bond rally caught most investors, even institutional investors with plenty of resources at their disposal, by surprise and ate into fund managers’ May performance, but most are still counting on equity markets to outperform bonds for the rest of the year, crediting the bond rally to everything from trouble in Ukraine to falling US deficits. But Organization for Economic Cooperation and Development (OECD) leading indicators that correlate with bond outperformance have been sending signals since January, says Gavekal co-founder Charles Gave, and they haven’t changed direction yet.

“The strong rally on long dated bonds has left many people scratching their heads,” writes Gave in a recent Evergreen Gavekal update. “After all, it is not every year that one witnesses double digit gains on the Commodity Research Bureau index, the S&P 500 (INDEXSP:.INX) make new highs, and long dated US bonds deliver the best returns of almost any asset class.”

But this confusion sends Gave to what he calls ‘one of the more reliable’ correlations that he uses to analyze markets.

OECD leading indicators predicted bond rally

But Gave says that OECD leading indicators have proven to accurately forecast the relative performance of equities to bonds even when other data, such as corporate or investor sentiment, is inconsistent or unreliable. When OECD leading indicators go up, future economic activity usually expands and investors should be overweight equities. When they start to fall, it usually means that the return on capital will soon decline and taking a more cautious stance with overweight bonds is prudent.

While Gave is careful to warn that he isn’t making a specific forecast, falling OECD leading indicators (shaded red in the graph below) have correctly predicted US bond outperformance relative to US equities every time for the last years, and they have been falling since January this year.

Gave recommends a balanced portfolio with 30-year bond exposure

Gave has been recommending that investors maintain exposure to 30-year bonds since the end of last year (a stance that he calls “as lonely as a Ukrainian military battalion in Crimea”), and since he doesn’t think the gap between bullish sentiment on equities and weak OECD leading indicators can last he maintains that this is still the best position to take. If OECD leading indicators start to pick back up (or US equity valuations fall off) then investors might want to reposition, but in the meantime Gave is in favor of a balanced portfolio.

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About the Author

Michael Ide
Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.

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