The bond market is where the big investment question of 2021 is playing itself out. Will the inflationary impulses that we are seeing everywhere prove to be short-term and self-correcting - transitory to use the Fed’s preferred terminology - or represent the start of a more worrying period of persistently higher prices?
Key to this debate is the credibility of the world’s central bankers. On either side of the Atlantic central banks are determined to nudge expectations towards the belief that the retreat from monetary accommodation can be slow and managed. During the first three months of the year they were fighting a losing battle; more recently they seem to have gained the upper hand again.
So, while year to date returns for government bonds have been negative, they have only been modestly so. So far, we have avoided a 2013-style Taper Tantrum. The so-called dot plots, showing rate-setters’ expectations for the future direction of interest rates, have brought forward the forecast of when hiking will begin. However, the market largely took this in its stride, pleased that the Fed looked increasingly on top of matters and was unlikely to let inflation rip.
So, government bonds look stable. Corporate bonds look more vulnerable because investors’ hunger for yield has driven them to valuations that we have rarely seen in recent years. The extra yield offered by corporate bonds compared with much safer government paper is almost non-existent. Investors are making heroic assumptions about companies’ risk of default in their desperation to squeeze out that little bit of extra income.
The fundamental picture for credit is supportive, with company earnings growing fast from last year’s low point. But no-one should imagine that spreads can tighten much from here. Investors are always going to require some extra yield to compensate them for the higher risk of lending to a company rather than a government. So, the only way that corporate bonds will offer more to investors than their income is if government bond yields fall. That looks implausible in the absence of an, unlikely, return to widespread lockdowns.
The other reason to be cautious about bonds generally is the increasing correlation between fixed income and equity returns. If the two behave differently an investor can always make the case for holding bonds as a diversifier in their portfolio. If bonds simply mimic equities, it is hard to argue against going all-in to the stock market while the recovery continues.
Select 50 picks: In the current environment, the most attractive part of the bond universe is probably inflation-linked. The ASI Global Inflation-linked Bond Fund could offer some support in an environment of rising inflation. Before you invest in a fund, please ensure you have read Doing Business with Fidelity and the Key Information Document (KID) relevant to your chosen fund.
Commodities has been the best performing asset class in the first six months of 2021, as economies have re-opened and demand for both energy and industrial metals has soared. That short-term boost has built on firm longer-term foundations, with talk of another commodity super-cycle becoming increasingly frequent.
Super-cycles are not common but when they do arrive they can persist for many years. Typically, they require a structural shift in demand for raw materials rather than simply a cyclical upturn in the economy. In the past these have included the industrialisation of the US in the 19th century, recovery from the second world war in Japan and Europe, the widespread adoption of the motor car and the growth of aviation.
This time, commodity bulls are focused on two driving forces. First, the political shift from austerity to fiscal stimulus, investment and social inclusion. This has the potential to trigger a long overdue rebuilding of the crumbling infrastructure in many developed countries, notably the US. Second, and related to the first, is the urgent need to combat climate change, which will require massive spending on green infrastructure.
Obviously, this has more positive implications for industrial metal prices than for oil in the long run. Shorter-term, of course, different factors come into play. The copper price had doubled since the worst of the pandemic slump last year, so it is unsurprising that it has corrected somewhat in recent weeks. The oil price has continued to surge, as OPEC producers have limited supply.
Gold marches to a different beat. Its price is determined by a variety of factors, including safe haven demand, inflation fears, the level of the dollar and real interest rates. The rise of bitcoin stole its thunder; the cryptocurrency’s recent retreat may now give the yellow metal a boost.
All that glisters is not gold
Source: Refinitiv, 30.6.21, rebased to 100 as at 1.1.21, total returns in USD
(as at 30 June)
|Oil (Brent Crude)||33.8||32.6||-1.6||-78.1||327.7|
Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.
Property has been the second best performing asset class in the first half of 2021 after commodities, as social distancing rules have been progressively eased and we have been able to think about getting back to work, into the shops and out to enjoy ourselves again.
What is clear, however, is that we are not simply going back to how things were before. Talk of everything changing for good is overdone. We are probably not witnessing the death of the city or the end of the office. However, it is plausible to argue that a decade of change has been compressed into a year or so. The world we return to may look familiar, but it will be different in crucial ways.
The chart here is interesting. It suggests that demand for office space is bouncing back as it did after the financial crisis and before that in the wake of the dot.com boom and bust. It is entirely possible, however, that we never need offices in quite the way we did before the pandemic. We have shown that for many people work is now likely to be a hybrid affair in which we collaborate face to face and do the ‘real’ work at our desks at home.
The property world is in a state of constant flux. The growth of online shopping creates demand for warehouses, while work from home disperses the centre of gravity of a city. Towns should become less zoned as we work and amuse ourselves closer to where we live. Perhaps most importantly, the property business is running hard to catch up with a climate aware world in which it is currently part of the problem not the solution.
And, in the meantime, real estate continues to offer investors a relatively high (although recently not so secure) income. As a diversifier and source of yield, property has a place in a portfolio, but quality of tenant, selection of manager and choice of sector have never been more important.
Will we really go back to the old ways?
Source: Refinitiv, 30.6.21.