Year-End Bond Market Rally on the Horizon?

Many people have heard of or experienced the end-of-year market trends in the A-shares, but the bond market has its own version of a "year-end rally."

Every year, factors such as policy debates, liquidity conditions, and proactive asset allocation make the bond market typically exhibit a wave of seasonal trading around the year-end.

Statistics since 2019 show that the bond market's "year-end rally" has been quite pronounced each year.

For instance, the yields on ten-year government bonds have consistently shown varying degrees of decline in December.

In particular, the declines in 2020 and 2023 exceeded 10 basis points, while in 2019 and 2021, they ranged from 6 to 8 basis points, and although the decline in 2022 was the smallest, it still registered at 2 basis points.

Why does the bond market also experience a year-end rally?

Several driving factors influence the year-end rally in the bond market:

At the end of 2019: Driven by asset allocation and liquidity resonance.

At the end of 2020: The Yongmei incident marked a peak in interest rates, while liquidity drove rates down.

Advertisement

At the end of 2021: The primary issues were relaxed liquidity, weakened credit demand, and recurring outbreaks.

At the end of 2022: Opportunities arose from liquidity-driven conditions and a wave of fund redemptions.

At the end of 2023: The main factor is the strengthening policy guidance for the transition between old and new growth engines, alongside deposit rate cuts.

Huatai Securities has summarized the common characteristics of the bond market's "cross-year trends" since 2019:

1) The fundamentals do not necessarily decline uniformly.

For example, at the end of 2019, the inventory cycle was nearing its bottom, and in December, the PMI showed a counter-seasonal recovery. The material and finished goods inventory indices fell by 0.6 and 0.8 percentage points, respectively, remaining in a state of passive destocking for two consecutive months. Had it not been for the subsequent pandemic shocks, market sentiment toward the fundamentals was generally optimistic then.

2) Policy debates are a critical variable.

Every December, the market closely watches the signals of stability and growth from the Politburo meeting and the Central Economic Work Conference. However, these two major meetings often do not issue specific policy tools, and in recent years, the policy tone has focused on stability. This often creates discrepancies in market expectations, providing opportunities for bullish bond market behavior.

3) Liquidity is an important driver of the year-end trends.

The five rounds of year-end rallies since 2019 have all been influenced by a relatively loose liquidity environment.

Historically, due to factors such as "cross-year" actions by financial institutions, liquidity assessments, and MPA evaluations, the year-end is often a time of relatively tight liquidity. However, the central bank tends to provide liquidity to counterbalance the situation, as evidenced by the steep declines in funding rates after mid-December each year, except for 2023.

4) The supply is typically low during this season, coupled with the "early bird" effect of asset allocation and trading.

The supply of interest rate bonds exhibits typical seasonal characteristics. Due to processes such as deficit reviews, the period from November to February of the following year is generally a low point for government bond supply. Therefore, for institutions like insurance companies and bank propriety trading, there is a tendency to "jump the gun" at year-end to accumulate assets, preparing for a "good start" in the following year.

Will the year-end rally in the bond market repeat this year?

Considering these factors:

Firstly, the fundamentals may still be in a "wave-like operation," and policy expectations have rolled back compared to October, shifting from "continuous proactive efforts" to "passively counteracting external shocks." It is expected that the market may actively speculate on discrepancies in expectations from the December meetings.

Secondly, on the supply and demand side, a major area of focus at the end of this year is government bonds. Last week's local government bond issuance was overall favorable. With banks preemptively arranging positions and anticipated central bank reserve requirement cuts, the risks associated with this round of local government bond supply may be manageable.

Another crucial demand driver stems from wealth management; a rebound in wealth management scales is also a positive factor. Wind data indicates that as of November 17, the total outstanding scale of wealth management reached approximately 29.6 trillion yuan, gradually filling the redemption gap since September. While wealth management is not primarily focused on long-term bonds, the declining yields on credit bonds may spill over to long-term interest rate bonds due to inherent undervaluation.

Lastly, central bank reserve requirement cuts at year-end are a key source of confidence for the year-end rally. Currently, the timing for reserve cuts seems to be maturing, with rate cuts unlikely to be rushed before the year ends. However, the downward space for rates may be limited, suggesting the need to seek opportunities for accumulation during peak supply periods.

In summary, due to positive factors such as policy debates, increased allocation in wealth management, and central bank reserve cuts, the bond market may still anticipate a year-end rally. From a medium to long-term perspective, the asset allocation value in the bond market deserves greater attention.

Bonds are income-generating assets, with their main and certain source of returns being interest income, theoretically regarded as an investment tool for "earning the time value of money" and an essential basic asset in asset allocation.

There is a certain "seesaw" relationship between stocks and bonds; if both are cleverly paired, it presents the opportunity to achieve 1 + 1 > 2 results.

When the stock market performs poorly or continues to adjust, bond funds may help preserve "strength" during turbulent periods, diversify risks, and reduce portfolio fluctuations.

For example, in 2018, the Shanghai Composite Index declined by 24.59%, while during the same period, the ChinaBond All-Bond Index gained 8.85%, and the Wind 中长期纯债型基金指数 increased by 5.9%.

When both stocks and bonds rise simultaneously, this pairing is likely to capture opportunities in both markets, thereby broadening sources of returns.

For instance, in 2014, the Shanghai Composite Index rose by 52.44%, while during the same timeframe, the ChinaBond All-Bond Index increased by 10.82%, and the Wind 中长期纯债型基金指数 rose by 12.61%.

Bond funds may also experience varying degrees of volatility; however, they usually exhibit smaller drawdowns and shorter recovery periods, demonstrating good "anti-shock attributes."

Particularly, pure bond funds display significant "anti-shock" effects.

According to Wind data, as of October 31 this year, the ChinaBond pure bond fund index's maximum drawdown in the past decade was only 2.71% (equivalent to the largest drop over the past decade being just 2.71%), which is less than 1/20th of the maximum drawdown of the Wind All A index during the same period.

With a pure bond characteristic and no stock investments, the Rongtong Stable Income 90-day holding period bond is currently being issued.

Fund manager Huang Haorong explained:

Pure bond funds are suitable as foundational assets in an investor's asset allocation. Moreover, from the perspective of asset allocation, pure bond funds have a low correlation with assets such as stocks, providing relatively stable returns during poor stock market performance, thereby balancing overall portfolio returns.

The Rongtong Stable Income 90-day holding period fund is positioned between medium to long-term pure bonds and short-term bonds, strategically maintaining a bias toward shorter durations to mitigate the effects of market volatility on the net asset value of the portfolio.

This fund primarily focuses on credit bond investments, focusing on medium to high-grade credit bonds, with AAA-rated varieties accounting for no less than 50%. Simultaneously, it employs a strictly internal credit rating system to mitigate the portfolio's credit risk.

In terms of investment, we will focus on selecting issuers in relatively stable industries with good cash flow, such as finance and utilities, considering varieties with higher credit premiums, like bank tier-2 capital bonds.

Additionally, when market opportunities are clear, we will utilize a portion of our positions for swing trading in interest rate bonds to boost portfolio returns, including government bonds, policy bank bonds, or relatively liquid local government bonds.

Huang Haorong possesses a decade of experience in the securities and fund industry, including seven years of experience in public fund investment management, having navigated through bull and bear markets with extensive experience in fixed income investment management. Currently, all publicly managed funds under his direction have yielded positive returns.