February 02, 2018

Fixed income floods

Management comment

The soft comfortable bond rug is being pulled out from under equity investors’ feet. The US 10-year bond yield target of 3% no longer appears unattainable particularly as this level is now almost compatible with current economic momentum. In the same way as rivers start to rise before bursting their banks, investors had seen the potential bond flood-risk warning and should now expect a change in paradigm in the fixed-income markets. However, the recent turnaround may well be considered salutary as the situation was becoming almost untenable among some valuations and following the surge in price in certain asset, such as the bitcoin.

The current correction among equity markets will provide more advantageous investment opportunities over the coming weeks and perhaps even the next few months. Change nonetheless always causes disquiet, with the market regularly testing the 1.25 technical threshold in the euro-dollar rate. Meanwhile, the yen continues to lose ground against the euro, which may cause Japanese exporters to skyrocket. The dollar remains problematic for the rest of the world however, as the US considers its currency as an adjustment variable. Although this is a dangerous game, it is ultimately the prerogative of the dominant economic power. Turbulence in the forex markets may erode several earnings-growth percentage points among major European multinationals.

Fears of a potential deepening of the US budget deficit following the tax reform and the (still hypothetical) launch of the $1.5 trillion infrastructure programme could further depreciate the dollar which, ironically, is etymologically rooted in the Germanic word thaler, the currency which was minted during the reign of Charles V and then prevailed in Europe over the next four centuries. Donald Trump’s protectionist stance is another cause for concern among investors who have become used to the idea of globalisation underpinning risk asset valuations.

Against the new economic and monetary backdrop which is taking shape, particular attention will have to be paid to valuations, particularly among equities. Although the European economic recovery is clearly gathering pace, investors should nonetheless avoid overpaying to gain exposure. Global imbalances also persist, such as the twin deficit in the US, combined with the excess liquidity provided by certain central banks and interest rates remaining at a level which is incoherent with future capital-return requirements.

2018 must therefore be considered as volatile year of transition, which is nevertheless conducive to taking certain calculated risks.

Igor de Maack, Fund manager and spokesperson at DNCA. This article was finalised in February 2nd, 2018.

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The soft comfortable bond rug is being pulled out from under equity investors’ feet. The US 10-year bond yield target of 3% no longer appears unattainable particularly as this level is now almost compatible with current economic momentum. In the same way as rivers start to rise before bursting their banks, investors had seen the potential bond...
2018-02-02