January has not boded well for bond markets. Strong inflation, an interest rate hike and predictions of more to come, both here and in the US. Bond fund managers have remained optimistic however.
Corporate defaults remain below the long-term average, managers say, and the macro economic picture is likely to slow down, not stagnate. Appetite for credit is still strong and spreads – the difference between yields on corporate and government bonds – are expected to widen only slightly.
Financial planners took a different view with all three this week giving the global and corporate bonds sector an amber or red verdict.
So who is right? Here is what this week’s experts had to say.
Our planners were fairly muted about the sector’s prospects until April, but Neil Sutherland, investment manager, corporate bonds, AXA Investment Management, was upbeat.
He said: ‘We are optimistic on bond valuations over the next quarter. We expect growth to slow globally throughout the year. The rate rises in the US and UK will start to take effect and the housing market will cool.
‘Although inflation is so high, it tends to be a lagging indicator. We are seeing stress, especially with the consumer. The market expects another rate rise, perhaps two. So valuations shouldn’t change too much.’
He added that the best time to buy bonds in the UK has been before the last interest rate rise in the cycle. We are approaching that point.
David Batchelor, Managing director, Wills and Trusts
The recent rate increase in the UK will make existing bonds less valuable. New bonds will become more valuable because they will have a higher rate.
There will be one more rate rise. So in the UK you should buy into new issues directly or a fund that is aggressively buying new funds or trading – for example, New Star Fixed Interest-rather than one that tends to buy and hold. In two months’ time you could buy into the funds whose prices will have fallen by then.
Globally there won’t be many interest rate changes in the next three months with the possible exception of the States. So new bonds will be less attractive but the second-hand market will be more stable.
Because of this diversity, it is impossible to call either red or green for this sector, so my stance is neutral.
VERDICT
Amber. A difficult call with so many factors involved.
Jason Stather-Lodge, Managing director, OCM Wealth Management
We urge caution in early 2007 as there are still questions over global economies. In the UK individuals have less disposable income. Consumer spending will slow, limiting further interest rate rises. This would be good news for bond investments as values should increase. However, the timing of this slowdown is not yet clear, and there will be at least one further interest rate rise before inflation comes under control.
The flipside of lower consumer spending is lower economic growth in the UK. This will eventually affect corporate profitability, and therefore increase the risk of defaults in the high yield sector.
Neither investment grade nor high yield corporate bonds are attractive opportunities for clients as there is so much uncertainty about the economy. Better returns – with far less risk – can be obtained from variable rate instruments, at least for the next quarter.
VERDICT
Red. Too much uncertainty to warrant the risk.
Russell Davidson, Managing director, Davidson Asset Management
The rude financial health of companies will support worldwide corporate bond returns over the next three months.
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