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The world in 2013, according to Jim Leaviss
by Dylan Lobo on Dec 07, 2012 at 10:43
M&G bond fund manager Jim Leaviss sees plenty of challenges next year but also finds reason for optimism.
2013 will be challenging but there is hope
M&G Investments bond fund manager Jim Leaviss expects next year to be tough but he can find reasons to remain positive.
While he says the UK still has a long way to go, with the recovery worse than during the great Depression, he draws comfort that the US is unlikely to go over the 'fiscal cliff'. In the eurozone he believes policy will be crucial and he thinks emerging markets still look a little expensive.
On the whole he believes that signs of a more positive outlook are beginning to emerge and that 2012 has been another good year for investors in bond markets. Bond holders have been rewarded, for instance sterling corporate non-financials have seen positive returns of 11.8% year-to-date compared to 10.8% for the same period in 2011.
These broad based gains in credit markets have occurred against a challenging macroeconomic backdrop and concerns continue over double-dip recessions in UK and Europe, rising indebtedness in developed countries and the risk of a significant policy error worldwide.
However, he highlights there are pockets of progress in some parts of the world. 'We do not expect a repeat of the very strong gains seen in the past year but are confident that there are still attractive investment opportunities in several areas of the fixed income universe. It depends on where you invest and what you invest in,' he says.
The following slides outline his vision for 2013 in five key areas.
UK: a long way to go
Despite a return to growth in the third quarter of 2012, the current UK recovery has been even worse than during the Great Depression – despite unprecedented stimulus, and the fact that promised austerity measures have not yet begun in earnest. The recent deterioration in the UK’s current account deficit of 5.4% of GDP is of particular concern and sterling looks extremely vulnerable in this environment.
Historically low yields on gilts limit their long term attractiveness. AAA rated or not, the UK government is likely to be seen as a shelter from the eurozone crisis and precarious macroeconomic backdrop. Leaviss believes that UK index-linked bonds continue to look attractively valued although proposed changes to RPI must be closely monitored. He also continues to favour non-financial corporates, believing the financials sector still has major structural challenges to face.
Central Bank Regime
Leaviss expects the Bank of England, with its new Canadian governor, will continue to steal the headlines in 2013. '2012 provided further evidence of what we have termed 'Central Bank Regime Change' – the unspoken shift in major central banks’ priorities away from targeting inflation towards boosting economic growth. Annual UK consumer price rises may have fallen from the 5.2% high reached in late 2011, but they have now remained above the Bank’s 2% target for three consecutive years,'
US: mission accomplished?
Most of the positives in M&G’s macroeconomic view are currently coming out of the US. Recent housing market developments are particularly encouraging looking into 2013.
Available housing stock decreased significantly in 2012 and is now below 4 months of supply, a level that has often preceded a strong pick-up in growth. Added to that, US house prices have been rising but remain significantly below their peak levels. The Federal Reserve has sought to bolster the market by shifting the focus of its quantitative easing programme away from purchases of US Treasuries towards mortgage-backed securities.
Leaviss remains confident on the US Dollar as well as US investment grade and high yield corporate bonds. His positive view on the US is based on the belief that the country is unlikely to go over the ‘fiscal cliff’ (allow automatic spending cuts and tax rises equivalent to 4% of GDP to come into effect) in 2013.
Neither of the nation’s two main political parties can afford to let the country slip into recession, the inevitable result of the fiscal tightening. Leaviss expects they will eventually agree on a near-term compromise, pushing out by a few years the date on which they have to agree a credible long-term solution to their debts.
Eurozone: moving in the right direction?
Looking at the eurozone’s withering economies, massive trade imbalances and growing social strains it’s hard to see how things could get much worse, or better, for Europe in 2013.
Leaviss believes the key area to watch in 2013 will be policy. On the plus side, the European Central Bank has recently adopted a more aggressive approach and appears to enter 2013 with a stronger armoury with which to tackle the region’s difficulties.
The institution has shown a greater willingness to consider non-standard rescue measures, leading yields on peripheral eurozone sovereign bonds to step back from the precipice. 'However, we’re still a little uneasy about the rally we’ve seen on the back of these moves. European policymakers have a history of letting problems develop into crises before eventually eking out a solution,' says Leaviss.
He urges particular caution when taking on euro exposure. German government bonds are likely to continue to fulfil the ‘safe haven’ role for nervous investors in 2013. However, with short-dated bund yields going sub-zero and those further out the curve little better, he has become cooler on the long-term prospects for these securities. Inflation-linked German paper seems to offer attractively priced protection against an inflation overshoot in the medium term.
Ultimately Leaviss believes peripheral countries’ government bonds should still be handled with kid gloves and his preference for core over periphery is echoed in the corporate sector.
Emerging Markets: still not cool
Leaviss points out M&G’s Fixed Interest team only lend to emerging market governments and companies on a very selective basis, believing emerging market local currency debt returns have been too highly correlated with equity markets, indicating returns have been fuelled by investor risk appetite rather than superior fundamentals.
Any large scale wobble in global investor sentiment could see the massive inflows of recent years reverse, with considerable consequences for investors. The rally in emerging market debt of the past few years has also left valuations looking too expensive.