The Year of the Pig
Earlier this month we witnessed the Chinese New Year and the start of the year of the pig. For the Chinese, the year of the pig has a specific relevance, good fortune and a beautiful personality. For the sceptics among us that view economic statistics from China with some caution, pig might stand for perpetually inflated growth as it would appear that the Chinese economy’s output is some way below the official figures. As the chart below from Barclays Research, sourced from the Wall Street Journal depicts, the probable outcome is some distance below the official figures since 2014 ended. Other independent research estimates paint a similar picture.
The Greater Fool Theory
Owners of ten year gilts will be feeling fairly pleased with themselves. Yields have fallen since the equity markets sold off in September 2018 from around 1.60% to 1.20% presently as shown in the chart below sourced from Investing.com
Holders would be sitting on a healthy unrealised capital gain in excess of 3%. It’s hard to believe that ten year gilts were yielding as much as 3% at the end of 2013 and as little as below 0.6% in 2016. Of course the depression in gilt yields coincided with continued buying from the Bank of England as part of its quantitative easing (QE) programme. With the Bank now absent as a net buyer, recent acquirers of gilts have been asset allocators exhibiting a flight to quality during the turbulent equity markets that prevailed in Q4 2018.
Even after this week’s below target inflation release of 1.8% (Consumer Price Index and shown below) for the year to end January 2019, gilt yields are below inflation and are an unlikely preserver of capital in real terms (in crude terms 1.8% less 1.2% equals a negative real return).
So gilts basically are trading like a commodity – buyers and sellers versus supply and demand. Buyers at current yield levels will no doubt be hoping for lower yields and consequently, some capital appreciation to compensate for below inflation yields. They will be hoping that investors with greater optimism for lower gilt yields will buy them. As we approach this year’s budget, the Chancellor of the Exchequer will be keen to invigorate the economy by spending more which may well increase the supply of gilts. It will come as no surprise to our regular readers that we do not like the above equation and have not held gilts, or corporate bonds priced off them, for some time and have no intention of doing so. Good luck to those who stick to old-style asset allocations based on fixed income and equities, to us, that seems illogical.