Bond market review quarter two 2011
When the outlook is very uncertain bond investors can take
comfort from holding assets which pay a series of visible cash
flows through the bond's lifetime and repay capital at par on
maturity. These are favourable characteristics when compared to
equity holders who may or may not receive a dividend and have no
certainty in terms of repayment of capital invested.
Bond investors do, of course, face investment risks and their
key consideration is always centred on credit risk - what is the
probability of the bond issuer being able to meet its liabilities
and service the coupons and redeem the bond. This question has been
at the forefront of the holders of Greek, Irish and Portuguese
government debt through this second quarter of the year. The issues
relating to Greece have made the headlines and the deteriorating
position prompted a sharp slide in risk assets, particularly in
June, as policymakers were forced by bond market participants to
present a credible solution to the solvency question Greece faced.
Readers will know the austerity measures demanded by the
International Monetary Fund (IMF) and EU did pass through the Greek
parliament and the next tranche of financial aid has been made
available. This said, European finance ministers, the European
Central Bank (ECB), domestic politicians and investors alike all
accept the solution has only bought time and a full resolution to
the peripheral sovereign debt crisis still lies some way off. The
spectre of thousands of Greek citizens protesting in the streets of
Athens, withdrawing their cash from the banking system, or leaving
the country highlights the problems that lie ahead.
Running in tandem with this storm in Europe has been the
disappointing newsflow pointing towards a deceleration in global
economic growth. Employment news in the US has been sharply in
focus with new job creation particularly anaemic and leading
indicators suggest the recovery has stalled. Austerity measures
across Europe have yet to properly bite and the UK is a good
example of this. The recent slew of news highlighting the difficult
trading conditions faced by retailers on the high street, points to
consumers reigning in spending as household incomes start to come
under pressure. Across most major developing economies, yield
curves have been flattening which may foretell an outlook for
slower growth. The yield curve in China has been flattening rapidly
and is now close to inversion - a slump in Chinese imports would
have a significant adverse impact on global growth.
Based on the above, it is not surprising to report a strong
performance from core European government bonds, Treasuries and
gilts through this reporting period. The safe haven nature these
issues enjoy resulted in a return of 2.17% from German bunds, 2.42%
from US Treasuries and 2.59% from UK government paper. The risk
averse sentiment that engulfed markets in June dented the quarterly
returns from fixed income sectors further down the credit spectrum;
however, they remained robust and were certainly less volatile than
equities. This story was typified by US high yield debt which fell
1.24% in June and returned 0.6% for the quarter. That said, this
sub asset class has delivered 4.65% through the first half of the
year which is a very attractive return on a relative risk/reward
basis compared with equities. The MSCI Index has returned 5.6%, but
has been much more volatile. Investment grade corporates across
Europe, the UK and the US returned 1.5%, 1.73% and 2.28%
respectively for the three months ending June and are up between
1.52% and 3.31% for the year-to-date. There is little doubt the
substantial foreign capital inflows into the longer end of
developing nations' bond markets have contributed to the flattening
of yield curves. Local currency emerging market debt had a solid
month in June and the JP Morgan GBI-EM Index has returned 6.9% over
the first half of the year, making it one of the top performing
asset classes.