Graham Campbell: why 2013 will be healthy for equities (but not bonds)

The problem with bonds

The purpose of Quantitative Easing is to keep the cost of borrowing low by distorting bond markets.

The UK government can borrow for 10 years at a cost of 2.4% p.a., despite the CPI running at 2.7%.  There are many examples of companies taking advantage of this anomaly. 

In the first half of the year GlaxoSmithKline issued a $2 billion 10 year bond yielding 2.85%. 

This year the company is expected to buy back £2-2.5 billion of shares which currently yield 5.5%. 

Similarly, Proctor & Gamble recently raised a €1 billion 10 year bond at an annual cost of 2.1%. The company also raised its potential stock repurchase programme to $4 -6 billion and its shares currently yield 3.2%. 

It has paid a dividend for 122 consecutive years since its incorporation in 1890 and has also increased its dividend for 56 consecutive years. It is no surprise that companies are using cheap money raised in the bond market to buy back higher yielding shares. 

While bond yields remain artificially low, many companies will use this arbitrage opportunity to boost earnings, improve cash flows and frequently reward shareholders with higher dividends. 

Politicians realise that austerity is not an attractive proposition for re-election.  Therefore, with printing presses running, many levers will be applied to stimulate growth.  History suggests there is a balance between encouraging growth and controlling inflation further down the road. 

Bank balance sheets continue to appear too large to us and behaviour suggests management is slow to realise losses and to pass on low borrowing rates to customers.  

This is depressing growth.  However, large corporates have direct access to bond markets and we expect this to be used to consolidate sectors and increase geographical coverage.