I have two contrasting (stylised) versions of equity markets: First, a forum to provide long-term capital where the objective is to harvest dividends that accrue from the profitability of a company and second, a speculative arena where investors bet on the future direction of a share without any sense of long-term commitment.
Short selling is a feature of the share price centric model where investors bet that a company’s equity is overvalued. As a firm advocate of taking a long-term investment horizon I have always favoured the first approach whilst acknowledging a role for the second in establishing market efficiency. Nevertheless, I sure I am not alone in having mixed emotions in relation to the trouble that some hedge funds have got into in relation to GameStop where private investors, using social media platforms, have discussed and subsequently bought shorted shares to drive the price up. This has forced some hedge funds to close out their short positions; the price movements have been spectacular – possibly a case of ‘biter bit’?
How is this relevant to fixed income? Well these gyrations have fed into credit markets where we saw last week some distressed debt rallying strong. A case in point was AMC, the cinema and online booking company, that has seen some of its debt issues double in price this month. The reality is that some companies have been able to use the price movements to issue new shares and bonds – taking advantage of the unusual circumstances. In addition, it demonstrates the potential power of private investors, particularly in cases where liquidity is low. Regulators will be very concerned about protecting private investors but in a free world of social media, online transactions and challenge to conventional ways of doing things it is going to be extremely difficult to control.
More generally, speculative bubbles show the problems central banks face. Quantitative easing (QE) has been used to stabilise markets at times of extreme distress. However, I believe that in the periods of relative calm authorities have been too slow to withdraw support. This has the effect of using up firepower but also diminishing the impact when really needed. QE has inflated financial asset prices but has been much less successful in providing real economic support. The result is more financial speculation and the growth of a short-term investment mentality. Ultimately, this is not healthy.
What does that mean? I favour more defensive strategies or those where I think I am getting paid well for risk. In the more defensive areas I think our absolute return, cash and short duration strategies look well placed. Returns will not be exciting but capital volatility should be lower than in other areas.
Economics and markets
Flash PMIs suggest another month of lost momentum. Although the US PMI improved, elsewhere data were soft. Supply chain issues, higher input prices, a worsening jobs picture, but relatively resilient business optimism were common themes.
US GDP growth slowed to 4.0% (annualised) in Q4. Growth in consumer spending was a bit less than expected with fixed investment being the surprise on the upside. Overall US GDP contracted by 3.5% in 2020 – significantly better than in the UK and euro area. The US remains likely to reach pre-crisis activity levels well before either of those economies.
Euro area PMI composite was soft, falling from 49.1 to 47.5 with services being particularly weak. The UK PMI composite was weak at 40.6 although UK business expectations picked up a bit in January. The message from data this week was that companies are facing higher input costs. In some cases this meant lower margins (euro area), while the pressure was passed onto customers in others (US).
China data for January was weaker than expected with further social restrictions impacting upon the service sector.
Cash, currencies and government bonds
There was little change on the week with 3 Month GBP LIBOR edging a bit higher to 0.035% and the US rate a bit lower – the latter reflecting a glut of cash in short-term markets. Currencies showed no big moves with the sterling / dollar rate ending just above 1.37 and the sterling / euro at 1.13.
In government bonds, US rates finished the week a bit lower with ten year yields at 1.08%. Elsewhere, the trend was for marginally higher yields with the ten year in the UK ending at 0.33% and Germany at -0.52%. Italian markets rallied despite a backdrop of political uncertainty. Real yields fell in the UK, taking the 30 year to -2.15%. This pushed up the implied breakeven inflation rate to 3.05%. In the US the trend was in the opposite direction with long-term implied inflation falling to 2.12%.
I am not a fan of government bonds at present yields – but given the speculative fever around, and potential for heightened volatility, the short end may represent a safe haven at the moment.
Spreads marginally widened on the week with sterling investment grade non-gilt credit spreads moving to 96 bps. This is still at the lower end of my expected range. New issuance was again subdued with new issues from Thames and Deutsche Bahn; we participated in both issues. Market liquidity remains reasonable; we continue to see flows into our sustainable and ethical strategies but are wary of green washing as more companies try to put a sustainable label on their debt.
Global investment grade credit was pretty flat over the week but we did see a widening in high yield spreads with my favoured measure moving above 4%. We bought a new issue from an Italian company that provides health care testing services and added to emerging market credit through a utility new issue.
High yield remains attractive given the favourable background provided by fiscal and monetary policies and is an area where RLAM is overweight. But events like March 2020 demonstrate the swings that can happen in this asset class – so investment horizons need to be considered.
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Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.