“You do get used to the volatility,” says Capital Invest’s Volker Steinberger, in Vienna, which is just as well as markets are showing very little sign of calming down. And so when US employment statistics are announced and the stock market gaps down 2% in the space of a couple of minutes, it is greeted with more of a shrug than angst. “And the big irony is of course that the figure was pretty much within the consensus forecasts,” says Dexia’s Peter Van Doesburg in Amsterdam. “Yes, it is unusual for the stock market to be reacting like this, but after recent months, we have almost come to expect this volatility.”
Though the historically high volatility may be seen as becoming the norm, it has not meant that bond investors have been rushing to alter their positions at every swing of the pendulum. Steinberger comments, ‘Since the volatility really took off in May, we haven’t changed our basic scenario although we have shifted closer to our benchmarks; with markets moving so much it makes sense. We were making changes earlier on in the year, however. At the start of the year we were positioned for a flattening of the yield curve, as we believed in the economic recovery scenario. However, with the big drop in equities we re-thought our positions and moved above our duration benchmarks.’
Reading the US economy has been difficult this year, agrees Van Doesburg. “A normal recovery from recession, if there is such a thing as normal, takes much longer than what we witnessed in the US at the start of this year. This time it was so fast, too fast, and the economy was destabilised. And that is the worst situation for us as investors: is the economy in recovery or is it going to contract again? We believe that there are still too many imbalances for there to be real recovery. But even if we don’t get a recovery just now then what we would all like to see is more stability even if that is with a weaker economy.”
Van Doesburg and his team argue that the economic situation on this side of the Atlantic is far more balanced and showing many more classical symptoms of entry into recovery mode. He points out that although the economic situation in Germany and Holland is ugly, France, Italy and Spain are doing better. “Europe is stable, not getting any worse or better. But of course Europe cannot pull itself up on its own. Look at how strong Europe’s Q1 exports were and that was mainly due to the super strong surge in activity in the US at that time. We need the US to be strong too – 2% growth in the US will not be enough to drag Europe out of the doldrums.”
“It is imperative that the US economy improve,” says Bank of Ireland Asset Management’s Ronan O’Donoghue, director and head of BIAM’s fixed interest team, in Dublin, “because although there is sluggish economic activity in the other major centres Japan and Europe, they are not showing independent growth themselves. The US consumer is once again holding up the whole thing on his shoulders.”
Steinberger makes the comment that his portfolios are currently neutrally positioned with respect to yield curve, but have maintained their long duration stance. “Another feature of this year has been the fact that swap markets in the (European) periphery countries have done much better than the core and so inter Government spreads have come in”, he adds.
“There is no need to take aggressive positions,” agrees O’Donoghue. “Interest rates will stay low for longer, but to get any significant rise in (bond) prices we would need to see a lurch in the economy and equity markets. This could feasibly happen, but it is not our central view. In a general sense, things are quietly improving, extreme leverage is being unwound which is helpful for companies. What is worth bearing in mind is that month after month for five months we have seen decent bond market performance. This is an unusually long period of sustained yield falls and so it seems only plausible to expect a choppy environment in the next few months,” he says.
“We may yet see another dip in yields at the long end. What happens in Iraq is a big question for us all, but this preference for fixed income markets will not be changing for a while, The best place to be is in longer maturity bonds,” argues Capital Invest’s Steinberger. “But you have to make sure your risks are controlled. This is certainly not the time to be taking big risks. Gambling on these markets is absolutely not what anyone with sense should be doing!”