By Mark Holman, managing partner, TwentyFour Asset Management
As 2013 commences, markets are faced with the unusual dilemma of having no obvious major road-bumps in their tracks, at least in the very near future. There are the Italian elections at the end of February, but that is still far enough ahead to have the bears heading for cover – at least for the time being.
Markets rallied strongly in the second half of 2012 despite the continual headwinds from both political and macro-economic uncertainties. This rally, initiated by Draghi, had the benefit of robust fundamental valuations and one of the strongest technical backdrops we have seen since March 2009. The largest potential pitfall was the fiscal cliff in the US which we’ve now seen partially averted and pushed back. It was certainly holding markets back in December, but having been cleared – from a market perspective – we have some clear ground for an early New Year rally.
We know that fixed income dealers have very little inventory at the moment and that the demand for income has rarely been stronger, despite the lower absolute yields currently on offer, so the technical position that gave the rally its legs in Q4 is still very much intact. With this in mind there is sure to be a huge wave of supply hitting the market in January, as borrowers seek to tap into this demand and get ahead of their funding requirements. We think that this new supply should offer opportunities for investors, especially those who require larger size tickets. Consequently we expect the majority of new issues to perform well, in addition to the secondary markets.
While this is really just a continuation of the existing patterns, a new trend is emerging in the traditionally “risk off” parts of fixed income – namely gilts and US Treasuries. The lack of a fear factor has pushed yields higher for both, with 10-year Treasuries hitting seven-month high yields and 10-year gilts moving above 2%. The benchmark 1.75% 2022 is now trading below 97.00, the lowest price since it was issued in June 2012.
While we do not forecast gilt prices to collapse, it is certainly worth noting that it has been a combination of Central Bank buying and fear that has pushed yields so low, and as currently neither of these are drivers, it is possible that we’ll see a reasonable sell off in January. There will be obvious knock-on effects to the highest quality end of the corporate bond market, which will struggle to make positive returns in this backdrop, but the lower end should see enough spread compression to keep overall returns satisfactory.
In terms of what will perform best, we continue to favour financials (with a particular preference for sub insurance) and good quality ‘high yield’ – so essentially a continuation of the firm trend seen in Q4. We will also be selectively active in the new issue pipeline as it emerges.
Wishing you all good luck for 2013.
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