Which are more volatile, U.S. Treasuries or Spanish government bonds? According to UBS strategist Ramin Nakisa, the surprising answer is U.S. bonds.
He argues that this is more than just an interesting piece of trivia. To his eye, peripheral European debt – most notably Spanish and Italian bonds – are very attractive investments today, with the euro zone's sovereign-debt crisis gone quiet and attention now focused on the U.S. Federal Reserve's goal of tapering its monthly bond purchases.
"After tapering talk began in earnest in June, Treasury volatility spiked, whereas peripheral bond volatility fell sharply after Europe turned the corner in July," Mr. Nakisa said in a note.
No doubt, favouring any European debt over U.S. Treasuries is bound to prompt some head-scratching among investors.
U.S. government bonds are the safest investments you can make, at least in terms of default risk. Despite a recent government shutdown, confidence in the United States' ability to pay its bills has kept the yield on the 10-year Treasury bond below 3 per cent over the past two months.
On the other hand, there were genuine concerns as recently as mid-2012 that Spain and Italy could default on their debt obligations, amid bailout talk, bank-sector rescues and fears that the euro might die as a currency.
However, a quick look at bond yields gets to what Mr. Nakisa is talking about. The yield on the 10-year U.S. Treasury bond has been bouncing around as the market tries to figure out when the Fed will start trimming its stimulative bond purchases, and what impact the tapering will have on the global economy.
The yield on the 10-year bond rose from just 1.6 per cent in May to a high of 3 per cent in September – a spectacular climb that had many observers announcing the death of the 30-year old bull market in bonds. (As yields rise, bond prices fall.)
For the 10-year Spanish government bond, though, the yield has steadily fallen from 7.5 per cent in 2012 – a record high for the euro era – to below 4 per cent by the start of November, after European Central Bank president Mario Draghi said the "ECB is ready to do whatever it takes to preserve the euro." The yield is back to where it was before the global financial crisis and European debt crisis erupted.
Mr. Nakisa said that investors kept away from Spanish and Italian bonds when yields were high because after adjusting for risk, the prospective returns weren't attractive. Now, though, risks have subsided and so the risk-adjusted returns appear far better, enticing investors who are looking for something sweeter than what low-yielding German or U.S. government bonds offer.
"If we look back over the last three months, then in risk-adjusted terms the combination of high coupon and low volatility makes Spain, and to a lesser extent, Italy, rank well above Treasuries and even emerging market sovereign debt," Mr. Nakisa said.
Spanish and Italian government bonds aren't the simplest assets for individual investors to buy. However, BlackRock Asset Management offers a couple of exchange traded funds that trade on European exchanges. The iShares Barclays Spain Treasury Bond ETF offers a yield of 3.5 per cent. Its Italian counterpart has a yield of 3.4 per cent.
Or, if you prefer a more diversified approach, State Street's SPDR Barclays Euro Government Bond ETF has a 2.5 per cent yield and provides considerable exposure to Spain and Italy.
But be warned: Diversification will bring German bonds into the mix. As the sovereign debt crisis recedes, the former bastions of safety now look like dead weights.
David Berman