Fixed Income  

Should investors go short or long?

This article is part of
Bonds vs Equities - May 2014

Markets may have surprised last year but since the end of 2013 the global economy has gone rather quiet in places.

Ian Winship, manager of the BlackRock Absolute Return Bond fund, insists it is an “interesting time” for the macro economic environment. He cites the news on April 30 which revealed US growth slowed to just 0.1 per cent in the first quarter of 2014. This suggests the severe winter in the country was far more of a headwind than predicted.

He admits there is little value in US treasuries but for those optimistic investors who are short bonds he warns that there is “still room for disappointment”, as evidenced in its recent growth trajectory.

Mr Winship sees more of a story in the UK where a broad based recovery is deemed to be underway. On the question of when the Bank of England (BoE) is likely to raise interest rates, he believes that if wages go up then the BoE could announce its first rate hike in the first quarter of 2015.

However, if the global outlook remains broadly unchanged then the Bank could hold out until the third quarter.

As for the “great rotation”, where investors move out of bonds and into equities, he sees no evidence to support this theory with investors undeterred from buying bonds, high yield and equities.

Investors seem to be agreed that Europe is in recovery, albeit tentatively, although the general consensus is that the European Central Bank needs to rely less on its vocal ability to persuade markets and take some action.

Dave Fishwick, head of macro and equities investment at M&G Investments, points to the “strong performance” of peripheral Europe and Italy in particular.

He explains: “The valuation of the Italian market, like its Spanish counterpart, appeared extremely attractive as part of the legacy of the eurozone crisis.

“Italian equities have since rerated strongly, driven by the financial sector, as investors have been encouraged by the prospects for a cyclical recovery and potential reform under a new prime minister.”

Mr Fishwick believes that with corporate earnings cyclically depressed and the scope for recovery, the market is attractively valued for the long term.

But he considers the underperformance of equity markets in Asia to be “more troubling”.

He says: “At face value, China remains on very attractive valuations, which we believe provides an important margin of safety in the event of negative outcomes. However, the country’s economic data has continued to disappoint so far this year, and from an ‘episodic’ investor standpoint, it is harder to identify clear behavioural forces behind pricing.”

The story in China is also keeping the fixed income team at BlackRock occupied who, at the start of the year, identified four themes they believed would “drive fixed income markets forward”.

Among those was central bank policy divergence, deleveraging in Europe and differentiation in emerging market debt. These themes and how they play out over the year could be a useful guide for investors navigating the path through bonds and equities.