The real ‘AAA’ bull market

What assets have performed well over the past month? Not surprisingly, assets with a lot of duration have had an incredible run as interest rate expectations have been pulled down sharply. Long dated gilts have returned over 5% in the last month, although year to date returns are still in negative territory. Interestingly, though, the dramatic spread widening of the past month has meant that long dated corporate bonds have hugely underperformed, returning just 2%. Long dated financials have performed particularly poorly on sub prime concerns, returning just 1%.

In line with this, I remain very cautious with regards to credit risk, and much prefer holding long dated AAA assets such as gilts and supranationals to get duration exposure. The market expects US interest rates to bottom out at 4.5% early next year, but history suggests the Fed tends to act very aggressively in the face of an economic slowdown. In the last two rate cutting cycles, it slashed rates from 9.75% to 3% in 1989-1992, and from 6.5% to 1% in 2000-2003.