Morten Spenner

The US continues to progress in its recovery. Despite the recent sequester which caused investors concerns, core data such as employment, consumer sentiment, housing and small business index reflect an on-going improvement that is expected to maintain positive momentum.

Outside the US, the data has been somewhat better than expected in developed markets (but not in great magnitude) with recent German, UK and, to a limited degree, French data showing positive signs. This helps provide continued optimism that a healing process is finally taking place in Europe and that 2014 will bring further confidence of a return to slow growth rather than a continued recession. In Japan, based on an unprecedented policy experiment, signs are also emerging of an economy picking up pace. Combined, this leads to a further reduction in the medium-term potential for a financial crisis re-emergence. That said, we are still witnessing a healing process which has further to go.

Unfortunately the growth momentum in ‘Developed Economies’ has to be set against raised concerns over the BRICS economies. While these economies will undoubtedly continue to grow, it appears to be at a slower speed than investors initially forecast and with continued credit concerns in China and reform delays in India. The so-called “Emerging Market” block thus – despite strong and differentiated performance from the “frontier markets” – are not expected to contribute to global growth to the same degree as previously. Consequently, we see the backdrop as one of steady growth and with low inflation for now but where geographical differences will become more pronounced.

With this steady growth backdrop, the more noteworthy changes are in the investment landscape. While low inflation enables the main central banks to continue their enormous monetary policy efforts, it also begs the question as to “what happens, when the experiment works?” The rosy picture of a return to growth and higher employment clearly has its attractions as a “destination” for the US, the European and the Japanese economies.

That said, the liquidity-injection of gigantic proportions that is QE has clearly taken us into unchartered waters. What can we expect once growth does become self-sustaining? How does the extraction process of central bank intervention work? What is the global impact of the extraction? Fed Chairman Ben Bernanke’s recent comments (stated twice now) vividly illustrated the conundrum around this situation and the jittery nature of markets as US (and many other) government bond yields moved both dramatically and swiftly. While we suspect central bankers and politicians are well aware of the potential negative spill-over effects from poor communication and monetary policy surprises, we firmly hold the view that the journey to a “reducing QE/post QE”-world will not be easily manageable and market volatility will reflect this. In addition, the economic data itself which will guide policy will most likely not be “linear”, giving cause for volatility and potential for inappropriate policy responses.

The market reaction to Mr Bernanke’s recent comments also posed tricky questions to developed sovereign bond holder.  The “great rotation” away from bonds including corporates into other investments may not yet have begun in anger (although outflows from bond mutual funds and exchange-traded funds in June show the largest monthly level of redemptions on record) but we feel that this is receiving considerably more consideration over the course of just a quarter.

Against this backdrop, we consider it relevant for investors to consider the dangers of enormous flows (problems with some ETFs are already been flagged) in markets, the increased reward for security selection and for optionality as well as trading ability with regards to market directionality plus the increased attractiveness of more complex, less liquid areas of the markets.  Investors face great challenges in how best to address these issues; those with clear investment solutions will be significantly better positioned.

Morten Spenner, CEO, International Asset Management

By Robert Marquardt, chairman and co- CIO of the Signet Group

Given the outperformance of high yield bonds during 2012, there is an emerging consensus that high yield is a bubble waiting to burst in 2013. However, though an increasingly crowded trade, the underlying macroeconomic outlook is still highly supportive of High Yield in 2013 and beyond.

The macroeconomic picture is improving, particularly following the semi-resolution of the American fiscal cliff, which will probably hold for at least the next two months. A change of political leadership in Japan has produced a wave of optimism that an aggressive fiscal stimulus may finally get to grips with the deep-seated problem of deflation. Meanwhile in Europe, Mario Draghi’s reassuring commitment to ‘do whatever it takes’ to secure the eurozone still seems to be keeping the markets content. However, the world economy still faces deep-seated challenges. It is better remembered that as we exit five years of crisis and recession, the next threeto- five years will be about repair and recovery. Central banks will most likely continue to support asset prices. Those predicting that rates will likely rise in 2013 are misunderstanding the fundamentals of a changed investment environment.

The underlying drivers of inflation are simply not present. Of crucial importance, the developed world’s economies are unlikely to experience significant expansion as a result of leveraging. If private credit fails to expand, individuals and firms will be unable to re-leverage, removing a crucial pillar of growth. Moreover, post-2000 the population of creative, tax-paying youth in the developed world is coming into balance with the elderly population. With fewer workers, on lower incomes, and retirees increasingly attempting to save and pay down debt, we cannot reasonably expect to see greater household spending or leverage. All this will not be improved by expansionary fiscal policy, as heavily indebted developed world governments remain committed to reducing their annual fiscal deficits, at least in the medium term. While the developed economies continue to de-leverage over the coming years, deflation will be a more formidable economic driver than inflation. Global aggregate demand is unlikely to exceed potential supply, thereby not impacting on inflation, wages, input costs or interest rates. In the short term at least, the macroeconomic landscape will remain supportive of high yield credit. The trends that foreshadow this are benign or slow growth in the developed world accompanied by disruptive politics, supportive central bank policy and lower systematic risks. Deleveraging is taking place very slowly, with developed economies remaining heavily indebted. Alongside this is continued quantitative easing, which will likely to lead to bullish outlooks for most asset classes.

Recently, minutes from the Monetary Policy Committee scared the bond market by hinting at restricting monetary easing later in the year. However, this remains unlikely. These factors point to an outlook that remains supportive of high yield. Most investors remain underinvested in risk assets and are gripped by uncertainty. Those who point to a bubble in high yield should remember that previous periods of debt reduction and repair have frequently taken over a decade to work out. Interest rate risk is not likely unless the macroeconomic factors that lead to inflation-shock return. Bond yields are likely to remain low for at least a further three years. In a macroeconomic environment that does not point to inflation risk, there are still compelling arguments to invest in high yield. The point remains, however, that this is an increasingly crowded trade. As a result, it is ever more important to select the best value, requiring a diligent analysis of a company’s balance sheets and operations. This highlights the importance of having a skilled, actively managed, approach to selecting the best off-therun opportunities.