By David Atwood, Global Strategy
Source: Refinitiv Datastream, Aberdeen Standard Investments (as of 10 July 2019)
The prospect of a global economic slowdown has caused many investors to retreat to safer assets, such as developed-market government bonds. So much so that Austria’s 2019 issuance of very long (near 100-year) debt was more than four times oversubscribed, for example.
Investors’ flight into these safer assets has driven the yields of many EU countries’ debt into negative territory. Somewhat counterintuitively, this means that investors know they will lose some of their principal if they hold the bonds to maturity. This phenomenon is not just confined to developed European countries. For example, the Czech Republic, Hungary and Poland all have euro-denominated debt yields that are negative at the short end of the yield curve. In fact, a number of European countries have higher percentages of negative-yielding debt than Japan. This “Japanification” of Europe is seemingly the new norm.
This world of negative yields has caused insurance funds, as directed by European regulators, to look further out in the yield curve for income. However, investors are hopeful that central banks will initiate rate cuts. Mario Draghi, president of the European Central Bank, recently announced that policy makers intend to lower rates and possibly reinstate quantitative easing in light of the global growth slowdown. The US Federal Reserve is also expected to ease later this month.
This sentiment has been supportive for bonds as well as risk assets. Equity markets are at or near all-time highs. The market has reverted back to a time of positive equity and bond correlation. European long-duration bonds, for example, have performed incredibly. The Austria 100-year bond has returned 60% from September 2017, while over the same period, the French 50-year government bond has returned nearly 40%. However, not all long-term government bonds are treated equally – Argentina’s 100-year issue would have lost investors 8%. Long duration cannot overcome political risk in this case.
Central-bank easing has been priced into bonds and equities, making bonds even more expensive than they have been over the past few years. Should easier policy lead to an uptick in global growth, then equities stand to benefit. If central banks fail to ease policy, however, there could be an aggressive selloff across markets globally.
In this environment, investors should consider choosing equity markets selectively and being conservative with risk budgets. European and US high-yield allocations, for example, may offer attractive risk-adjusted returns over their respective equity markets.
The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.
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