We are still in a bull market… for complacency

In today’s complacent and expensive bond markets, an active and flexible approach is needed. We look at where the risks and opportunities lie.



Philippe Lespinard

Complacent markets

When markets are not even reacting to missiles being fired over Japan, it shows we are still in a bull market for complacency. Aside from a few areas of value, they are expensive, particularly in the bond space. It is in our view essential to avoid owning the index. There have been huge flows into passive fixed income strategies, but those strategies do not distinguish between the actual assets that they invest in; they buy the whole market. It is important to invest with the managers that actually do the analysis, are ready to pick where there is value and avoid other areas of the market.

Expensive markets require flexible mandates

Although bond market valuations are high, we still see areas of value. The key is to be flexible, agile, and to be able to move capital and not be stuck in one specific asset class. In the corporate bond space, we would look at so-called extension strategies which provide exposure to the market but are also selective in where they take risk.

Opportunities within emerging markets

Within emerging markets, notably within Asian fixed income, we like local securities and there are lots of opportunities. Risk premia (i.e. the perceived risk) have come down, inflation has eased and currencies have strengthened. Many investors were afraid to invest because of fears over China’s economy. As a team we spent a long time debating China and, although we acknowledge the challenges, we are ultimately pretty confident that China’s economic growth is sustainable. We therefore favour the Asian region in general, given that, partly because of China, many securities had a significant premium attached.

Global economic growth is accelerating while US is stagnating

One of the main surprises this year has been the reversal in the reflation trade. Many of us began the year investing on the basis that President Trump would deliver his economic agenda: 3% GDP growth, protectionism and hundreds of billions of dollars in infrastructure investment. None of this is happening. Indeed, the dollar’s weakening trend this year has been in part a consequence of the fact that markets no longer believe in the Trump reflation story.

In contrast, who would have said that the eurozone would be accelerating to the point where last year suddenly it was slightly ahead of the US in real growth terms? This recovery is now broadening out and even Italy, which has been the regional laggard, is seeing accelerating growth.

There has been a huge amount of capital leaving the eurozone to go to the US. Looking at our client flows, this has largely gone into US dollars and we now expect some of that capital to start to return to Europe. It is likely to happen in the equity market, which has been lagging, but also in other parts of the market too.

Brexit will not lead to a European crisis

The risks stemming from Brexit are slightly overdone, in our view, certainly on a global stage, but maybe also on the European stage. The existential priority for the European Union is the integrity of the eurozone and the single market, not Brexit. So the economic and political negotiations are likely to be complicated and the UK is increasingly at risk of a bad outcome. However, the UK has very strong ties with its allies on the continent, particularly in the intelligence and military communities. These geopolitical ties are likely to be maintained despite a likelihood of ongoing rhetoric in politics.

The Bank of Japan is preventing global tightening

The Bank of Japan keeps confirming that there is no plan B for Japan, only plan A. This is to keep yields at zero until inflation restarts. Consequently, when bonds mature, many investors don’t reinvest in Japanese government bonds, they invest abroad and buy US or even European securities.

There is therefore a large amount of liquidity leaving Japan for other global markets. We think this may ease many of the concerns about the Federal Reserve’s balance sheet normalisation and expectations for the European Central Bank to gradually withdraw quantitative easing in 2018.

Emerging markets are increasingly resilient

The important thing to remember about emerging markets (EM) is that they have implemented reforms which are essentially structural. Export-driven business models are being adapted to be less reliant on global trade patterns. As a result, the risk premia on EM assets should decrease.

Although a few EM countries have healthy financial balances and are rated by ratings agencies as investment grade, they still have a risk premium because they have suffered political instability or because institutions are weaker. But as governance is tightened and political management improves, we are likely to see risk premia continue to fall.

With specific regards to China, we expect that the country’s financial system will continue to reform with the aim of moving towards more open capital markets.


Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. Emerging markets generally carry greater political, legal, counterparty and operational risk.

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Philippe Lespinard