Over the last decade, equity investors have seen extreme volatility and a couple of plunges into the abyss, and back. This has resulted in conventional investment beliefs rightly being challenged and a flight to the perceived safety of bond investing.

There is now a risk that investors may treat the last decade as normal rather than abnormal. Bonds have outperformed equities over the last decade, but such outperformance is extremely rare. There is a real risk today that as investors focus on investing in what are perceived to be low-risk sovereign government bonds from core Eurozone countries, they are buying in at historic highs and will face capital losses.

The macro outlook for the decade ahead is for slower but positive growth as we work through the headwinds from the amassed debts of the past. The world’s central bankers have taken unprecedented actions to stem the evolving debt crisis. Globally, investors have poured funds into government bonds and yields have fallen to extremely low levels (typically around 2%) in Germany, the UK, the US, and Japan. This was partly because of fears of prolonged global recession/depression. While those fears have very definitely receded, bond yields remain very low, for now.

The relative valuation between equities and government bonds has become extreme. In 2000, the yield on German 10yr government bonds was almost three times that of European equities. Today, it is close to the opposite, with German 10 year bond yields at 1.8% and European equities giving a dividend yield of about 4%. This extreme of valuation occurs in an environment where global central banks are attempting the greatest reflation exercise in 80 years. One thing is for sure – if they succeed, holders of 10-year bonds at a yield of 2% will see heavy losses!

Many now challenge the view that core Eurozone government bonds are “risk free”. Such bonds may still be free of default risk, but not price risk, and investors run the risk of buying into assets that are already in bubble territory.