Continuing our countdown to Christmas, Ian Spreadbury says there is still value in bonds but efficient allocation and careful liquidity management will be required for healthy risk-adjusted returns.
2016 was dominated by central bank action and political developments, culminating in what you might call a 'double regime change' - Brexit and a change of government in the UK, and the election of Donald Trump as president in the US. It will inevitably take some time to assess the impact of these developments on the global economy, but my broader thesis of subdued growth and inflation remains unchanged.
While economic and political transitions over the next 12 months may lead to a bit of volatility in yield terms, there are powerful structural headwinds to the global economy which remain in place.
The first of these is debt. Global debt to GDP is higher than it has ever been before and that debt will require servicing, repaying and refinancing. This leaves the economy sensitive to interest rate changes.
Second, there is the demographic issue. The global population is ageing quickly and the share of people dropping out of the workforce as they move into retirement continues to grow. This is negative for the total number of hours worked.
Last of all is global inequality. Wealth is increasingly concentrated among a small percentage of people but this group is more inclined to save rather than spend additional wealth than the rest of the population.
If my thesis of slow growth and low inflation continues to play out, yields will remain low in a historical context. Fixed income returns surprised to the upside in 2016 and, given the starting point for yields, we would expect medium-term returns may well be lower than we have been used to. Japan's experience of persistently low yields in the past two decades demonstrates the impact of protracted low nominal growth and low interest rates.
There is a wider question of whether a move to a more aggressive fiscal policy in the US and elsewhere would change the big picture. On balance, I do not think that will be the case and nominal growth will remain low.
First, any rise in yields feeds back into the economy. We saw that during the 2013 ‘taper tantrum' where rising yields hurt the economy very quickly. And the more recent increase in US yields has already driven up mortgage rates.
Additionally, a shift towards protectionism has led to a stronger dollar and weaker emerging markets. Remember that emerging markets are now a bigger chunk of global GDP and, if a stronger dollar persists, it may prove to be a headwind for global growth.
On the whole, there is still some value in bonds at these levels. With all the macro and political changes, however, efficient allocation, conservative name selection and careful liquidity management will be required for healthy risk-adjusted returns.
Ian Spreadbury is a senior portfolio manager at Fidelity International.
Partner insight advertorial. For adviser use only
The views and opinions contained herein does not constitute advice. This has been created for financial adviser use only, and is not intended for use by individual investors. Past performance is not a guide to future performance. The value of an investment can fall as well as rise and is not guaranteed which means your clients could get back less than they invest.
