Member Article

Numbers in safety

Richard Clark and Simon Patterson, private bankers at Barclays Wealth and Investment Management in Newcastle, look at gilt markets.

What do you think of an investment trading within a whisker of its all-time high, at a valuation never seen before, which is potentially volatile if interest rates start to rise and which is all but guaranteed to deliver a fall in price and a negative return in ten years?

Welcome to the weird and wonderful world of the gilt market. With the exception of War Loan, all conventional bonds, including now the 1¾% 2022, are trading above par – that is, above their redemption price. Yields out to 2025 are below the Bank of England’s inflation target of 2% (a target that has been exceeded, on a rolling 12-monthly basis, since 2005, and likely will be until 2015 at least). And this week it went up further.

Fear

Many other bond markets are in similar territory, essentially because their holders remain scared, and are willing to tolerate such return-free risk simply for fear of finding something worse. With the Bank, the Fed and now the Bank of Japan committed to owning a large portion of their local markets, and with Italian and Spanish bonds seen as risky, the free float of high quality government bonds has shrunk. It doesn’t take many new buyers to push prices higher.

There is of course plenty to be scared about. The eurobloc economy is flat-lining and Spain’s budgetary progress is again disappointing. Many commentators continue to question whether the US can grow its way out of the (alleged) Great Deleveraging. North Korea’s idiosyncratic foreign policy is managing to embarrass both the US and China, and the risk of a military accident in the peninsula looks even higher than usual. Avian flu has broken out in China. Several central bankers are warning of complacency and the risk of a sell-off in stock markets.

High bond insurance

Even so, the insurance provided by government bonds at these prices looks prohibitively expensive to us. Euro angst about Cyprus at least should have eased a little as Mr Draghi has said explicitly what we’d assumed was the case, namely that the policy of making depositors there pay is not a “template” for wider resolution of the current crisis (beyond 2015, in future crises, things may be different, and we’re not convinced that bank depositors will ever see themselves as bank “investors”, but that’s another matter). The US economy seems to have grown in Q1 by 3-4%, twice as fast as originally pencilled-in, and it would be remarkable if there weren’t now some slowing in Q2. The latest labour market data are not game-changing.

Events in the Far East are difficult to call: the antagonist is unpredictable (perhaps because its internal situation is more precarious than it looks), but its big neighbour will probably keep it from the edge, as it has to date. Meanwhile, South Korean stocks may be volatile, but we think they remain a good long-term play on that ongoing US recovery.

Bonds versus stocks

Stock prices have rallied a long way, and in some cases are also historically high. But in contrast to government bonds they look inexpensive: their yields are not particularly low, because profits and dividends have been rising too. We still meet few complacent investors (and as noted, the behaviour of bond markets hardly suggests general complacency). A setback in stocks remains overdue, but it’s bonds that seem to us most likely to underperform strategically from here.

As always, we do emphasise that investing in shares is not for everyone. Their value can fall and you can get back less than you invest – if you are unsure, you should seek independent advice.

This was posted in Bdaily's Members' News section by Barclays Bank PLC .