Bonds bubble hotly debated
Bonds bubble top of the agenda.
Gains possible from QE and other stimulus policies.
Alarm sounded for volatility ahead.
Commodities weakness likely as equities outperform.
Featuring this month’s experts:
In this monthly investment spotlight a selection of experts from leading UK wealth managers give their summary of investment tips in June 2015.
findaWEALTHMANAGER.com is a gateway to the UK’s leading wealth managers and we regularly tap their expertise for the benefit of our users. These past few weeks, the effects of monetary stimulus, the ongoing “Greek tragedy” and fears of a bubble in bonds have been top of the agenda.
Are bond bubble fears overblown?
Tom Becket, Chief Investment Officer at Psigma, says:
There has been a lot of hot air wasted in discussions about bond bubbles over the last few years, as yields have collapsed and prices have soared in the extraordinary world of zero interest rates and Quantitative Easing that we now live in. However, the last few weeks have been extremely interesting (read worrying) for bond investors.
On “bubbles” our view is simple: despite the fact that countries like Germany and companies like Nestle have been able to borrow for free (or even been paid to do so) it does not mean there is a bubble in bonds. Nor does the fact that Mexico, a country of dubious borrowing in the past, has been able to issue 100-year bonds at yields of close to 4%, mean that bonds are bubblicious. We just think they are bad value. With bonds, unlike equities, property or commodities, you should always know what you are going to get in the form of a nominal return, as long as default is avoided (those Nostradami who can predict Mexico’s next century are certainly smart).
So let’s stick to the bad value theme we have held for well over a year and evaluate recent moves in bond markets and what we have learnt from the mini shocks of February and May. To be clear, we do not think the re-pricing in yields higher is over, although in the short term market interest rates might have moved far enough. In the medium term, we expect the upward pressure on yields to continue, and we think that February’s weakness in bonds might well have been the “opening salvoes in a grim war for bonds”. Our words have proven unusually prophetic and the last few weeks have been really challenging for assets connected to government bond yields. Our view that yields were to rise and avoiding bond duration was key to investment success, has started to work well.
Chief Investment Officer at Psigma
Careful stock-picking essential
Rosie Bullard, Portfolio Manager at James Hambro & Partners, says:
Monetary stimulus around the world is a contributing factor in our current asset allocation and investment strategy. We have been taking money out of the US, which is the most expensive of the major regions and where earnings and share price momentum has started to deteriorate versus other parts of the world. It appears that Quantitative Easing has done its work by helping the US economy onto a surer footing and our view is that a lot of equity upside from that is reflected in current valuations.
However, we see opportunities to benefit from ongoing monetary and economic stimulus in other regions. We have been putting some of the proceeds of our reduced US exposure into Europe, Japan and to some extent Asia-Pacific – markets in which we are modestly overweight and where we feel there are equity gains to be had as a result of QE and other stimulus policies.
We are underweight the UK, but following the General Election result, we have added to domestically-facing UK cyclical stocks, such as house builders and financials. We think these will benefit from the positive effect of the Conservative majority on consumer and business confidence.
Our investment philosophy is such that we are always looking for long-term positions. At stock level that often means businesses in a niche or specialist area, with unique or differentiated products and services which give them strong competitive advantages and market share. We’ve found some interesting opportunities on these lines in the UK engineering sector lately, which we are currently weighing up (and may be able to tell you more about next month if asked!).
Elsewhere, we’ve been increasing our underweight in fixed income on concerns about flows from the bond market in anticipation of interest rates rising. We’re not expecting an all-out panic, but if investors start to see sustained losses in the bond part of their portfolio – supposedly a “lower risk” asset class – then selling momentum could build.
Portfolio Manager at James Hambro & Partners
Beware volatile times ahead
Nigel Cuming, Chief Investment Officer at Canaccord Genuity Wealth Management, says:
May is often the month when financial markets pause for breath and, given the strong start to the year that we enjoyed in the first quarter, it is likely that markets will struggle to make significant progress in the short term as there are several headwinds. The ongoing “Greek tragedy” still has the capacity to unsettle markets in the summer. At the time of writing many commentators are refusing to rule out the possibility of an eventual Greek default, especially as the economy has fallen back into recession and depositors are once more removing their money from Greek banks. This is forcing the ECB to again provide them with emergency lending. Whilst the most likely scenario is that a fudged deal will be struck at the last minute, there could easily be some nervous moments for markets over the next couple of months.
Another area of volatility has been the bond market, which fell sharply in April. As we expected, much of the talk concerning deflationary pressures has now abated and longer term inflation expectations have started to increase quite markedly with the oil price rallying 35% year to date. We feel that this sell-off in government bonds is not the start of a bear market, but more likely a short term buying opportunity. While ongoing European Quantitative Easing should underpin the market for now, it does remind us how painful it will be when the bubble that has been created in bond valuations eventually bursts. What is of particular concern is that the recent violent price swings have been exacerbated by the absence of liquidity as a result of regulatory changes. Many banks are now either unable or unwilling to make markets in bonds, with the stock of bonds held by broker-dealers down from US$300bn in 2008 to US$50bn today. This will not be a temporary problem and it is probable that in the event of any major shocks, central banks would be forced to make the markets themselves.
Chief Investment Officer at Canaccord Genuity Wealth Management
European equities set for continued outperformance
Patrick Armstrong, Chief Investment Officer at Plurimi Wealth, says:
Central bank policy has been main driver of markets in the first five months of the year, as the European Central Bank started a quantitative easing policy, which led to a strong rally in European equities, and a weak euro. We expect a divergence between ECB and the US Federal Reserve will be the most significant factor in the second half of 2015, and extend the European equity rally, while the US lags.
To date, US growth has been weak enough to defer Fed rate hike expectations, but strong enough to avoid equity sell off on risk aversion. The start of a rising rate cycle is our base-case scenario for the next 6-12 months. Fed Chair Yellen’s qualification of the first quarter contraction in US GDP as “transitory” has set the stage for the first rate hike in September. If US payrolls come in at +150,000 per month – then unemployment will be sub 5% by year-end, and it will be difficult for the Fed to maintain a zero interest rate policy with a sub 5% unemployment level. We do not think the US equity market is pricing in a hike, and US Valuations are full. The S&P 500 is approaching tech bubble valuations on a Price/ebitda basis (10.3 today, vs. an all-time high of 10.7 in March 2000), and on a price/book (P/B) value basis the index is at 2.9x. These elevated valuations increase the risks of a rate hike-induced de-rating. Europe is in a completely different environment.
The ECB is more likely to extend QE beyond 2016, than begin tapering earlier than promised, and valuations in Europe have risen with the rally, but are still significantly below US multiples. In our opinion European banks offer the best value. Valuations for financials remain compelling, with the sector trading at a 40% discount to the broad equity market on a price-to-book basis. We have seen signs of growth in credit demand, and expect that proactive central bank policy will be a positive for the financial industry.
Our funds are also long European industrial equities. Global growth will provide a tailwind for the outperformance of the sector over the next 6-12 months. The industrial sector trades in line with the broad market on most measures, but we expect the sector will benefit from a weak euro, and a stronger than expect eurozone economy, and this will result positive earnings revisions.
Despite a positive view on the global economy we expect continued weakness in commodities. Our macro fund is short gold and short oil. A strong US dollar and healthy economy will diminish demand for gold for the second half of the year. We expect there would be a strong supply response should oil prices move above $65 a barrel, and this will limit any significant upside. Oil ETFs have a very high cost of rolling futures as they expire, and this makes them good short candidates in our opinion.
Chief Investment Officer at Plurimi Wealth
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