It is nigh on impossible to argue government bonds are good value when more than $10 trillion of them (circa 30 per cent of the market) trade with a negative yield. Monetary policy’s race has very much been run. Governments are waking up to the idea that it is time for them to grab the baton and use low, or (even better) negative yields to borrow money and invest.
Austerity politics appears to be on the way out. In Japan, we have recently seen the approval of $132bn of fiscal measures put forward by prime minister Shinzo Abe. China is already well under way and the US and the UK appear to be turning a corner. New chancellor Philip Hammond has said he will move away from George Osborne’s austerity with a stimulus package put forward in the autumn statement this month.
These measures would boost spending expectations, which are already high. Developed market spending is set to double in the next 15 years and developing economy spending is set to almost triple. Much of this spend will likely be on transportation and other things that drive growth: roads, rail, schools and housing to name but a few.
While infrastructure is a theme that can benefit from helpful policy, there are also parts of the market tilted more towards value that can benefit from having a margin of safety implicit in their valuation. Examples would be European and Japanese equities.
Both these markets are trading at significant discounts to the US market (which counts for circa 60 per cent of the global equity market and hence swamps returns if one invests globally), have companies that are growing margins and delivering earnings growth.
These value types of equity markets should also perform better in an environment when interest rates are rising. Although this may well be a long way off in the UK (due to the Brexit-induced slowdown), it is expected in the United States.
Donald Trump’s presidency might have rattled markets and delay that somewhat, but it is likely that the future path is upwards. The table below indicates the outperformance of value stocks in such an environment.
While this relates to equities, it also rings true for investments in bonds, with expensive sovereigns (the darlings of the past 35 years) under the most pressure. Within fixed income, we advocate allocating to smaller companies that are less susceptible to the forces of rising interest rates (and the negative effect this has on bonds).
Furthermore, smaller corporations in Europe – one of our preferred regions – are much less exposed to passive buying and the distortions this sort of ownership can create in times of stress. Smaller European corporates and asset backed securities offer a healthy yield (approximately 6 per cent), which provides an attractive return and a healthy cushion should markets sell off.
