By Charles Rawson is a fund manager at Exeter Fund Managers Equity markets appear to be in the ...
By Charles Rawson is a fund manager at Exeter Fund Managers
Equity markets appear to be in the second-worst bear market in fifty years and have suffered their worst three-month decline since 1987.
Although they have bounced substantially from their recent lows, they have lost around 20% this year and around 40% since the peak of the technology, media and telecoms bubble in December 1999. No one is sure yet if a genuine recovery in equities is imminent or whether markets are set to plumb much lower depths.
It is ironic that the background now, with inflation, interest rates and unemployment at their lowest level in a generation, could not be more different to the 70's bear market. The background then was of stagflation (stagnant economic growth accompanied by rampant inflation) and rising unemployment.
Unlike the 70s, however, today's environment is almost ideal for risk-averse bond investors.
Government and top-rated corporate bonds have benefited from the flight to safe-haven assets following the technology collapse, the cataclysmic events of 11 September, other geopolitical tensions, the fragile state of the global economy and company finances, and a succession of (mainly US) accounting scandals and record bankruptcies.
In the UK, there has been the additional factor of a structural shift by pension and insurance funds from equities to bonds, with pressure on solvency margins acting as a catalyst.
Thanks to the controversial new accounting standard FRS17, it has been estimated that the aggregate deficit on the UK's corporate pension schemes rose to about £70bn at the end of July after stock market falls.
These and other investors have been switching out of equities into bonds and, within bond portfolios, switching from higher risk corporate bonds to lower-risk bonds in their quest for safety and liquidity.
One significant development in recent weeks has been the almost complete reversal of sentiment regarding the direction of interest rates in the US, UK and Europe. Central banks have moved towards an easing bias.
The reason for this change of tack by the authorities is their concern that there is now a significant risk of a double-dip recession following the slump in share prices and, more recently, poor economic data releases. This virtual volte-face by the central banks has given government bonds another boost. Ten-year gilt yields have dropped from around 5.0% at the end of June to just over 4.5%, largely on the back of the gloomier economic outlook and changed interest rate stance of the monetary authorities.
However, a faltering global economy, corporate credit problems (bond defaults have reached record levels) and accounting scares are hardly good news for corporate bonds. Even investment-grade bonds have not been immune. Sterling bonds in this category have underperformed gilts, with yield spreads widening from around 1% a couple of months or so ago to 1.5% at the time of writing.
While the economic outlook looks so uncertain, the safest course of action is to stick to sovereign and corporate credits of the highest quality, ideally AAA or AA rated.
Flight to safe havens has benefited bonds.
Move by central banks towards easing bias.
Structural shift by UK pension funds.
Bond defaults have reached record levels.
Faltering global economy.
Recent corporate scares.
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