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Diary of a fund manager - 21st Century Times - 11.02.19

David Miller, Investment Director, Quilter Cheviot

In this week’s Diary, whether bond and equity markets are sending contradictory messages, the important difference between waiting with purpose and just waiting when it comes to making decisions, and some reflections on this year and this century.

After a cracking start to the year for equity investors, last week was rather quiet. Markets ended slightly better on balance, but nothing to get excited about. Bonds continued to make good progress, whilst both gold and oil fell back. The dollar was better for choice.

As the sugar rush delivered by the Fed and also the results season moved towards its end point, investors are starting to focus on the prospects for the rest of 2019 armed with better information than was available just a month ago. Markets aren’t always right, but they are a useful barometer of opinion. Starting with bond markets, the signal for some time has been that talk by central banks about higher interest rates was unlikely to turn into action. This is what the Fed confirmed the other day, now joined by the Bank of England. It seems that the global economy just isn’t vibrant enough to tolerate a return to ‘normal’ interest rates. Approaching 20% of bonds still offer zero or negative returns if held to maturity. Ten year German government bonds currently yield 0.1% compared to 0.7% a year ago. Even Brexit- torn gilts are acceptable to investors in return for 1% per annum for the next decade. Current prices are a long way from suggesting that an inflationary boom is imminent. Over in the US, where economic growth has been stronger than in Europe, US Treasury yields are still over 2.5%, but have been on a downward trend this year. Depending on who you listen to this extra return is Trump risk, the impending weakness of the dollar, or the sheer scale of the US government’s funding requirement for the foreseeable future. Let me count the trillions.

Implicit in any calculation of the value of a bond is the borrower’s ability to repay investors capital on maturity. Governments, with their control of taxation and the printing press, have options not available to the rest of us and so tend to be regarded as good risks. This working assumption is occasionally wrong, but usually this only happens when governments borrow in currencies other than their own. The Eurozone is a special case which is why Greece had trouble ten years ago and Italy now. Corporate borrowers in contrast, are more dependent on their credit rating which, in general terms, is a measure of the financial health of the company. Post credit crunch, banks have been much more careful about lending and so instead companies have borrowed by issuing debt to income starved investors. Those looking for something to worry about could start in the US where 50% of investment grade bonds in issue are rated BBB, which is one notch above what is euphemistically known as high yield, but used to be called junk. Since 2008 the size of the BBB market has increased from $700 billion to about $2.5 trillion which is a not insignificant sum. A growing US economy matters to those invested in this part of the market whether they know it or not.

Equities seem to be telling a different story. For example, the technology heavy NASDAQ index is 15% higher than at Christmas. Analysts, now with up to date guidance from companies are downgrading profit forecasts for this year. Growth yes, but only lukewarm optimism. Pockets of weakness in German manufacturing and Asian exporters are genuine reasons for caution. Companies are reducing capital expenditure budgets, but consumers remain in a buoyant mood. Unemployment levels are low which is good for confidence. As Ronald Reagan said; ‘ A recession is when my neighbour loses his job. A depression is when I lose mine.’ Over on this side of the Atlantic we might say ‘I’m alright Jack’.

In summary, bond markets are sending a clearer signal than equities, but there is common ground. Investors remain alert for change and at the moment the likely catalysts are in the hands of the politicians. News about US/China trade negotiations move markets. Brexit, in contrast, is having a more nuanced effect. Both in the UK and the EU we await something closer to clarity. Constant meetings, statements of strongly held views, bad body language and more votes in Parliament have all lost their potency through inconclusive repetition. The consensus view is that financial markets would be surprised by ‘no deal’. Waiting can be a good investment strategy, but not waiting to make a decision. At times like this gathering information, judging what is important and being ready to move is very important. Delaying decisions until the 29th March just isn’t good enough, because no date in the diary ever delivers complete certainty. As General Eisenhower said, ‘plans are worthless, but planning is everything.’

January is over, Christmas credit card and tax bills have been paid, it’s getting lighter in the evenings and it’s safe to go back to the gym as New Year resolutionists head back to the bar if no longer the pub. It’s shaping up to be a challenging year. On reflection, perhaps a better way of looking at it is that with nearly 20% of the 21st Century done, we are certainly living in interesting times.

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Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

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