How the world changes. Twelve months ago investor sentiment towards fixed income markets was almost ...
How the world changes. Twelve months ago investor sentiment towards fixed income markets was almost universally bullish, after a storming year which had taken yields in some cases down to levels last seen in the 1950s.
Leaving aside such exceptions as Greek government stocks and long dated UK gilts, that consensus has proved to be less than inspired.
Now the pendulum has swung to the other extreme with bonds receiving few votes amid the stampede for technology stocks.
This year is set to be a strong year for global growth and central banks are likely to respond by raising interest rates.
That is widely seen as ensuring that yields on global bonds will continue to rise. This cautious valuation assumption is our starting point.
Markets hate uncertainty and during such phases they inevitably tend to err on the side of pessimism while giving little credit to positive developments.
Inflation-adjusted yields on government stocks of western countries are already reflecting this; on this basis yields on the US and German 10 year benchmark are over 4%.
Such yields are becoming quite defensive and should limit downside risk.
Furthermore, we believe that bond investors are taking insufficient note of the implication of increasing globalisation and of e-commerce on headline inflation rates.
This combination could develop into a powerful theme in the coming year, prompting a more favourable review of interest rate assumptions.
If it becomes apparent that the peak of the current interest rate cycle may be in sight and at only moderately higher levels than at present, investor sentiment would shift significantly.
Furthermore, the increasingly healthy state of public finances in the West (though not in Japan) will lead to lower issuance of government debt, thereby creating an advantageous supply/demand position.
The past year has been eventful for the development of corporate and high yield bond markets and these asset classes are likely to gain greater recognition in the coming year.
Investors have tended to take a very cautious view of credit risk, with the consequence that yield spreads are currently very high.
A more positive global macro-economic picture should lead to a more helpful operating environment for corporate issuers. This should, in turn, be reflected in improved credit ratings, leading to lower yield spreads.
There is already evidence that this is happening in the US high yield market.
A similar point can be made for emerging market debt, where spreads have started to move in significantly.
Careful stock selection and thorough analysis of credit risk are the keys to unlock these high yield opportunities.
We expect good returns in 2000 from many of these high yielding bonds.
Currency fluctuations continue to play an important role for UK-based bond investors.
In 1999 the strength of the yen flattered returns from Japanese bonds in sterling terms. We believe that the euro will recover over the course of the coming year.
Combined with our optimistic assessment of developments in the European high yield debt market this implies attractive returns for UK-based investors in 2000 from that source.
The rapid growth of the corporate bond market in Europe, coupled with accelerating investor demand, is raising the profile of this asset class.
In addition, the strengthening prospect of countries like Poland and Hungary joining the European Union create exciting opportunities to buy their high yield government debt.
John Hatherly is head of research at M&G Group
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