23rd March 2015
We have written extensively recently on moves in bond yields and currencies and general expectations of lower long term growth and inflation and, within that, economies and monetary policy that are increasingly on divergent paths writes David Jane, manager of Miton’s Multi Asset funds…
The recent weakness of the Euro versus Sterling and the Dollar is considered to be a consequence of QE, as is the extraordinary strength of continental government bond markets. While US and UK government bond markets may have peaked at the end of January, German yields have continued on lower, now only 20bps at ten years.
So bond markets and currencies are now on a different path worldwide and this may offer some opportunities. We have had a view for some time that the US, being further forward in the recovery process, offers some further potential for currency strength, especially when considered from a much longer perspective.
While the trade weighted index may be up 25% from its lows last year, a much longer term view shows it still a long way below its longer term peaks. With the US labour market going from strength to strength, and potentially having room for interest rate increases, this trend could continue for much longer.
The same goes for the weak Euro, with QE now in place and a desire for the stimulatory benefit of a weak currency, there seems little to prevent the Euro continuing its trend lower. We would also expect this trend to continue for some time.
So, how might we benefit from these potential moves? We see little value in buying Eurozone government bonds at these levels, as the potential for capital gain is minimal, and, however strongly we might believe the trend may continue, there is potential for material losses from these elevated levels. We do however find good potential in equities in the Eurozone, particularly in the mid-sized beneficiaries of a weak Euro, where expectations have been slow to catch up with events.
Similarly, there appears to be some good potential from the bonds of such companies, particularly if they are shorter dated. The yield curve at the shorter end remains quite steep, giving potential for capital gain and, although spreads are extremely low by historical norms, credit risk is improving and there appears to be a reasonable prospect for attractive absolute returns.
In the US, much the same applies. We have moved our equity exposure to a strong domestic bias, avoiding the big international companies which are suffering downgrades as a consequence of the strong dollar and are considering some US high yield credit exposure, where yields are quite attractive compared to elsewhere.
As ever the UK seems stuck in the middle, sterling has been a little weaker lately even against the Euro, possibly reflecting the upcoming election, and this is probably helpful for the corporate sector. We have a portfolio more focused on the domestic mid-sized names, looking for beneficiaries of improving real wages and a better Eurozone economic background.
As a general rule, we tend to expect trends to continue, whilst being alert to the risk of change. It seems reasonable to expect the trend of a strong dollar/weak Euro to persist for some time and there seems to be policy support for this trend and no compelling valuation argument against it. For these reasons, the beneficiaries of those trends are likely to continue their strong momentum. We have the Euro largely hedged, while we have exposure to a strong dollar in our unhedged US bond and equity positions.