The summer months are traditionally a period where limited liquidity and the absence of any real news flow lead to exaggerated moves in markets. Some of these moves may be justified, giving a hint at the future direction as we head into the more meaningful trading period of the autumn. Some, however, are just sound and fury signifying nothing.
The challenge is of course, to try and work out what is meaningful and what is not. Our approach has always been to consider the facts first and then to look for where the market’s opinion differs from that supported by evidence. We look for divergences between the data and the narrative.
The big summer move has of course been a further drop in bond yields, now at the levels seen during the slowdown in 2016. This move has had a knock-on effect on all other lower for longer assets, such as growth equities and defensive stocks, and has now led to relative lows in value plays, especially banks and cyclical stocks.
The near-term economic data has continued to deteriorate, now also in the US, supporting the outlook for lower interest rates. Aggravating and relating to this trend is the ongoing threat of further impacts from de-globalisation, most visibly between the US and China. The pressure on yields remains lower on the back of the news flow. In the short-term the market acts like a voting machine, responding directionally to each incremental piece of data.
The medium-term question is whether the market has over-reacted, in terms of level. Over longer-term periods, the market should act more like a measuring machine. With yields less than 2% all along the US curve and below zero at all maturities in Germany, this does suggest something of an extreme view regarding the long-term outlook for growth and inflation. Perhaps it reflects the expectation that unusual monetary policy will continue well into the future and that yields have permanently decoupled from growth and inflation expectations. Either way, we seem to be at a near-term sentiment extreme.
We have been trimming some of our positions in long-dated government bonds. We believe that yields will remain lower for longer however, we are always as concerned about risk and portfolio construction as we are about return in the short-term. In our view, the market would be much more surprised by some positive economic data than further negativity. Basically, at current yields, the risk seems more that good news leads to a significant rise in yields than further bad news leads to falls.
In summary, we feel there is a good chance that we have seen a summer over-reaction to news flow, rather than a fundamental reassessment of the long-term economic outlook by the bond market. While we remain firm believers in the lower for longer paradigm for the time being, we have been trimming some of our more aggressive positions.
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Changes in the interest rate will affect the value of, and the interest earned from bonds held within the Portfolio. When interest rates rise, the capital value of the Portfolio is likely to fall and vice versa.
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Source for information: Miton as at 28/08/2019 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
Miton has used all reasonable efforts to ensure the accuracy of the information contained in the communication, however some information and statistical data has been obtained from external sources. Whilst Miton believes these sources to be reliable, Miton cannot guarantee the reliability, completeness or accuracy of the content or provide a warrantee.
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