The bull market for bonds may be on its last legs already, as governments the world over will soon tap the debt markets to fund stimulus packages aimed at shortening the global recession.

The flood of newly available sovereign debt will drive down the value of existing bonds by correcting the current supply-demand imbalance.

“Sovereign bond markets have been one of the few places to find shelter for much of the last year, but that safe harbour is increasingly threatened by the flood of issuance needed to finance already large and growing government deficits,” says Jeffery Rubin, CIBC World Markets chief economist and chief strategist.

Aside from the supply and demand dynamic, Rubin points out government deficits have historically hurt bond investors, as inflation becomes more palatable to policymakers.

“With as much as 50% of Uncle Sam’s debt owned by foreigners, expect the printing presses to be working overtime at the Federal Reserve Board,” Rubin says.

To safeguard against the predicted retreat from fixed income, Rubin is adjusting the weighting of his model portfolio, shifting 1% out of bonds into cash.

Rubin predicts two more quarters of desperately bad economic data before the trillions of dollars of global government stimulus eventually finds its way into the economy. The vast majority of the spending — up to $650 billion U.S. over two years — is aimed at improving infrastructure, yet many investors seem to be missing the opportunity this presents.

American companies with exposure to the coming build-out have rallied, but Rubin says Canadian and global stocks in the same sectors have yet to join in.

“Governments, the world over, are now buying jobs and investing in the future by ramping up infrastructure spending,” he says. “There may still be time to capitalize on the pending (infrastructure) boom.”

The leading targets for spending are energy — particularly the relatively clean hydro-electric and nuclear power plants — along with transportation and healthcare.

Not only will the usual suspects — transit manufacturers and engineering firms — benefit, but also the IT suppliers.

“Even the most ambitious fiscal plans and measures taken by the (U.S. Federal Reserve) and other central banks to date won’t prevent GDP in most of the OECD from printing negative in the next couple of quarters, and intensified weakness elsewhere,” says Rubin, predicting global GDP growth will fall to just 1%.

Ever the optimist, he predicts that a recovery will emerge in the second half of this year, driving the S&P/TSX index to 11,000 by year end — a 22% gain over Monday’s opening.

These gains will be fueled in part by a surging gold sector, as investors seek shelter from inflation.

“If the U.S. monetizes its huge fiscal deficits in the near future, bullion will be poised to set new record highs, benefiting from both higher inflation and a weaker greenback,” he says.

(02/09/09)