Looking up, but not yet party time
The macro-economic environment is getting better for bonds, agree many investors, although no-one seems particularly ready to celebrate. “We are more positive on bonds in general, not least because the global growth indices are still pointing downwards,” says Pictet’s Rajeev DeMello. However, Pictet has not yet upgraded its US bond positions from neutral to positive, believing that there might be too much negative economic news already priced in and that the fourth quarter could contain some ‘nasty’ signs of economic strength.
For Robeco the economic outlook for US bonds seems quite benign. Bob Galesloot explains: “Indications of a global cyclical slowdown have increased during October. In the US we have a soft landing scenario with moderating growth and inflation under control. We are sticking with our duration-neutral position in the US market because, although our qualitative analysis continues to be positive, our duration model is still signalling negative for the US dollar markets as a whole. The flatness of the US yield curve is a negative factor for the model.”
Within Europe, Galesloot and his colleagues have been more active, as he explains: “In the middle of October we went overweight within Europe. However, our duration model then turned more negative at the beginning of November because of recent price rises in the commodity markets, and we have since cut our European positions back down to neutral.”
Pictet’s DeMello, although not particularly enthusiastic about any of the world’s major bond markets, thinks that, on balance, European bonds will have the edge in the medium term. He explains: “We do prefer European bonds right now. The worries that the US market has priced in just a bit too much negative economic news do deter us somewhat. For Europe, on the other hand, this is not the case and we think there is a possibility that growth which is already showing signs of lagging in this third quarter, could weaken further.”
The dark cloud over European bonds’ prospects remains the strength or otherwise, of the currency. DeMello voices his concerns: “The possibility of a much weaker euro is a risk factor in our analysis. We believe, however that the 80cent level versus the US dollar will be held by the European Central Bank. The ECB has moved away from interest rates to intervention as a means of support.
“There are huge reserves, even if they have to do the intervention on their own. We can draw parallels with the Bank of Japan’s single-handed, yet ultimately successful, intervention last year.”
For Rossen Djounov of Forsyth Partners, the outlook for the euro is considerably gloomier. He explains, “We have been in the bear camp for much of the euro’s short life, and are happy to remain there. The two fixed income fund managers we currently use, Pimco and Mercury Asset Management, have both been correctly forecasting a weaker euro.”
He continues: “Neither manager is ready to change their view because they both argue that the euro is an inherently artificial and political creation made up of a basket of very different countries built upon disparate economic and fiscal models. What is good for one group, is often bad for the rest.”
Getting the currency wrong has been a major worry for European investors this year. There have been further pitfalls awaiting in the growing credit sector where spreads have been widening since the start of 2000. DeMello says: “They have been so volatile in recent months. I guess we have been in an overall credit bear market since January 1999, with sporadic crises pushing spreads wider and then the market never quite managing to close the gap before the next incident.”
Investors, however think now is not the time to be credit-averse, and with many believing that there could be at least a technical rally, if not one based upon fundamentals. DeMello explains: “I am positive over the next three months for a couple of reasons. Firstly, the new issues pipeline is drying up; and secondly, high yield markets are back up at US 1991 default rates and they’re pricing in a hard landing.
“The credit market is very, very worried. I do feel it is all a bit exaggerated and I certainly do not concur with an outlook of Europe about to go into a tailspin.”