* Rising bond yields significantly upsets market status quo
* Skewed positioning could see sharp unwinds into year-end
* Politics, earnings, policy shifts key risks
* Bond yields vs dividend yields: reut.rs/2ehgNek
* Global equity valuations: reut.rs/2edc3rQ
By Jamie McGeever and Vikram Subhedar
LONDON, Oct 18 If October's bond jolt
reverberates through a politically nervy end to the year, many
funds fear it may trigger an exodus from all richly valued
financial assets as investors re-price intertwined stocks and
bonds and hurry to protect 2016 gains.
Record low bond yields have snapped higher suddenly this
month as investors sense a shift away from ever-easier money and
credit policies from the world's big central banks toward more
use of government tax cuts or spending to foster growth.
According to a Bank of America Merrill Lynch survey this
week, global fund managers say the biggest driver of world
stocks over the next six months will be U.S. bond yields. Three
quarters of those polled said Treasuries are too expensive.
The pop in yields, which rise as prices fall, comes as
investors struggle to make sense of populist politics across
much of the developed world and how it may affect governments
and central banks, increasingly desperate to boost growth.
Potential turning points are scattered through the political
diary over the coming months: November's U.S. Presidential
election, Italy's constitutional referendum in December,
Britain's plan to start talks on exiting the European Union in
March and 2017 elections in Germany and France.
At the same time, signs are growing that the days of very
cheap money are winding down.
The U.S. Federal Reserve continues to point to a 2016
interest rate rise in December. European and Japanese central
banks are reluctant to signal any new monetary easing ahead, and
sterling's Brexit-fueled devaluation of near 20 percent has
aggravated the UK inflation picture, probably taking further
Bank of England easing off the table.
Add a rebounding oil price that has almost doubled from
January's trough as OPEC countries consider supply cuts next
month, and you have a potentially toxic mix for debt markets.
As monetary pumping has lifted nearly all financial assets,
a bond shock could force a dramatic repricing across the board.
If pricey bonds and stocks get knocked over, there could be a
dash for the exits to lock in gains in both before yearend.
There is ample room to fall. Of 23 assets that Reuters
typically tracks for quarterly roundups of global markets, 17
are up year-to-date, many of them handsomely so. For a graphic,
click on reut.rs/2doKMRd
"The chance of a major bout of volatility this year is
rising," said Joachim Fels, economic advisor to Pimco, one of
the world's largest bond funds. "Markets have been sedated and
seduced by the low interest rate environment and dovish central
banks. This paradigm will be tested, possibly soon."
In one measure of how expensive stocks and bonds have
become, Bank of America Merrill Lynch reckons their relative
price compared with real estate and commodities is its highest
The limits of this gap may be at hand as political pressure
to cut wealth inequality is driving policy away from the
quantitative easing and negative interest rates that raised
prices of financial assets, BAML told clients.
What's more, BAML's latest fund manager survey shows that
bullish bets on bluechip stocks, investment grade corporate
bonds in the United States and Europe, and low volatility
strategies are the top three crowded trades of 2016. All are
vulnerable to rising bond yields.
Some of the world's leading stock indices are at or close to
their record peaks and valuations near their highest in a
decade, despite lackluster corporate profits. reut.rs/2edc3rQ
Corporate earnings worldwide are expected to grow just 1
percent in 2016, according to Thomson Reuters data, a weak
recovery from last year's fall.
Ongoing troubles at European banks, slowing growth in China
and the impact of a strong U.S. dollar on emerging markets and
commodities continue to mar the outlook.
Yet yield-starved investors have pushed blue chip stock
prices to new highs by latching on to historically high relative
dividend returns compared with near zero bond yields across much
of Europe and Japan.
Traditional investment behaviour has reversed, in that many
funds have been investing in equities for income and in bonds
for capital gains. For many this persistent buoyancy of equities
is simply down to TINA or "There is No Alternative."
Analysts at Citi argue that there is less economic
uncertainty than usual: forecasts for growth, inflation and
interest rates are unusually stable. But that could create risk.
"This is problematic for investors. A perception of higher
certainty creates consensus, consensus creates complacency and
complacency creates risk, particularly when the consensus view
is reflected in congested, consensus market positioning," Citi's
Tina Fordham and Tiia Lehto wrote on Monday.
And if key readings of market volatility are any guide,
these risks are nowhere near fully factored in.
Implied volatility on euro dollar, the most traded
exchange rate in the world, has been rarely been lower than
current levels over the euro's 17-year lifetime.
(Reporting by Jamie McGeever and Vikram Subhedar; Graphics by
Vikram Subhedar; Editing by Mike Dolan and Peter Graff)