30 Nov 2022
Since markets have fallen, fixed-income products have become a credible alternative to shares. And the underlying factors that brought us disinflation in recent decades are expected to continue, even if not as powerful as before.
The value of a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Whenever performance is mentioned, past performance is not a guide to future performance.
Through dovish monetary policies, base-rate cuts and quantitative easing, central banks had ended up squashing bond yields – so much so that everyone thought there was no alternative to shares. It was a period of TINA (There Is No Alternative): the logic used to justify some excessive approaches.
But now all that has changed. Those same central banks – starting with the Fed – are today tightening their monetary policies ever more to get a grip on inflation. Since the Swiss National Bank hiked its rates on 22 September, only the Bank of Japan is still living in an age of negative nominal rates.
All bond markets – from credit and developing-country bonds to high-yield bonds and emerging-market debt – have lost between 15% and 20% in 2022. British gilts have been among the worst performers.
Yet there is good news too: this asset class now offers many opportunities, in our view.
TIPS (Treasury Inflation-Protected Securities) – US government bonds index-linked to the Consumer Price Index – now provide positive real rates. This translates in a yield that is 1% – even 1.5% – above inflation for 10 or 30 years.
If you do not expect a dive into recession – as we do not – then corporate debt should also take up its rightful place in your portfolio. Good-quality US corporate bonds offer returns above 5% at five years, compared to just 1% only two years ago – that is five times more.
And high-yield bond spreads are nearing 550 basis points above government bond yields in the US – and even 600 basis points in Europe because of the premium from the war in Ukraine. These levels foresee a hard landing for the economy – but in our view such a scenario is far from certain. We can see the same trend in some emerging markets that offer very high yields despite limited default risks.
Still, should we not fear a long-term scenario of uncontrollable price rises that is not factored into rates?
To predict how inflation will unfold in the long term, you have to consider the underlying drivers of disinflation we have seen for decades – and ask whether these have gone.
The main driver among these structural factors is globalisation. Since China became a member of the World Trade Organisation in 2001, we have been able to buy ever cheaper consumer goods.
Has this trend now run its course? No – even if you might suspect it will wane when you look at a certain series of events: a trade war between Beijing and Washington, Brexit and the return of customs barriers in Europe.
We believe technology and innovation will also continue to act as restoring forces. There has not only been a fall in prices of household appliances, computers, cameras and suchlike, but the effect of Amazon too. This global e-commerce platform helps both consumers and firms now see the fair value of products much more easily. That will carry on impacting inflation, as will the gig economy through weaker job security and fiercer jobs-market competition.
If you fear a return of 1970s stagflation, it is worth remembering the balance of power between workers and capital is still in the latter’s favour. Unionisation has stabilised at a low level and wage-indexation systems have nearly disappeared.
Of course, disrupted supply chains and bottlenecks will keep inflation alive in the short term. But inflation will remain a temporary trend, in my view. For example, the labour supply in aviation is the same as it was before the pandemic, yet air traffic is still 15% below its pre-pandemic level.
The forces of globalisation and technology have been so powerful that central banks have doubtless been wrong to take credit for disinflation. Central banks’ capacity to bring prices down to their targets through a restrictive policy alone should be put into perspective.
In our view, a hike in the ECB’s rates will have less impact on Russian gas prices in Germany as diversified supply and the energy transition will.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.