October 26, 2015
by Robert Huebscher
If there truly were a “bond king,” it would not be Bill Gross or Jeffrey Gundlach. It would be Dan Fuss, whose tenure in the fixed-income markets has spanned more than half a century. In a talk last week, Fuss warned investors to expect higher interest rates along with higher taxes.
Fuss spoke on October 22 at the CFA Institute’s fixed-income conference in Boston. Fuss is vice chairman of Boston-based Loomis Sayles and manages the firm’s flagship Loomis Sayles Bond Fund (LSBDX).
[drizzle]“In the fixed-income markets, we have to deal with low rates and low inflation,” he said. “Both will rise. That is not a real good combination.”
This is not the first time Fuss has warned of higher rates. He did so in March 2015 and in October 2013, causing his fund to miss the full benefit of bond rally in 2014. In April 2012 he made a similar, but incorrect, prediction.
Nonetheless, LSBDX has performed admirably over the last 10 years, returning 6.73% and beating the AGG index by 2.05%, placing in the 8th percentile of its peer group, according to Morningstar data. Its performance this year has been less impressive, returning -3.32% and ranking in the 92nd percentile of its Morningstar peer group.
I’ll look at Fuss’ comments on the global economy and bond market and at his assessment of some asset sub-classes within the fixed-income universe.
The four Ps
As is his standard practice, Fuss reviewed the global landscape through his “four Ps”: peace, people, prosperity and politics – and a fifth dimension – the role of central bankers.
Peace – or lack thereof – dominates Fuss’ thinking. He expressed concern about developments in the Middle East and in Eastern Europe, but his greatest fears are with the developments in the South China Seas. Nonetheless, with regard to the latter, he said he was optimistic that issues with China will be resolved.
In terms of prosperity, his greatest concern is with the pending growth in the defense budget. He said it was “quite reasonable” when Defense Secretary Carter said “it’s about time to take the uncertainty away from the military so they know their budget.” That budget, according to Fuss, is “much too low to deal with the evolving situation in the word.” He said it’s been a long time – about 50 years – since the U.S. faced a gradual acceleration of defense spending, but it is about to do so now.
“Unless something really changes,” he said, “that will happen.” He forecast that defense spending as a percentage of GDP will increase by 1-3%.
Because of that, Fuss said the government will need more revenue. He warned that the tax on investment income will increase. He said that will carry implications for relative valuation between taxable and tax-exempt sectors in the bond market, but he did not say what those implications will be.
On the “people” front, Fuss said that across the developed world population growth is slowing or declining. Japan is the prime example because it is unable to maintain the size of its workforce population. In the U.S., he said, demographics will cause bonds to become more attractive than stocks for private-sector defined-benefit plans (and less so for public sector DB plans). Presumable, this will exert a downward pressure on rates, but Fuss did not say so.