JP’s Journal: Insights on next year

Last week was active despite the pre-Christmas feel to markets. Government bond markets showed big daily gyrations whilst credit spreads continued to grind tighter. But it was also busy on the communications front – with Ewan McAlpine leading the monthly fixed income Five Point Podcast and Asset TV hosting our Investment Outlook for 2024, which went out last Thursday.

It is probably worth reviewing some of the themes that came out. From Trevor Greetham’s viewpoint, the Investment Clock is stuck in the “cross hairs” with growth and inflation indicators fairly neutral. This increases the focus on data and is likely to make market trends news dependent. From an asset allocation perspective, we remain overweight equities, have a bias towards short-dated high yield bonds, and cautious on commodities. From the perspective of real estate, we feel that this is the one asset class that has priced for recession.

Peter Rutter, Head of Equities, sees opportunities across the globe but is concerned about how higher bond yields could impact valuations. Anyone interested in how to manage active equity portfolios would do well to listen to Peter – as he and his team have delivered tremendous value to our clients. It is a great example of what Royal London Asset Management do well. A clear investment philosophy, implemented by experienced people operating in a collaborative and focused team; we think this approach will work better than the approach touted by many other managers which combines multi-jurisdictional location and banks of near-consensus analysts that often result in a disjointed approach.

Ashley Hamilton Claxton, who leads our Responsible Investment team, provided insights into how data and technology is changing the way we can analyse companies. Some of her examples are eye opening. She does caution about the challenges ahead for sustainable investment strategies in the light of the FCA’s recent update on proposed regulation and is aware that this will provide a big challenge for the industry next year.

From a fixed income perspective my stance remains that investment grade credit will outperform government bonds next year – more through excess carry than via spread compression. The yield moves in November make me more cautious on longer duration bonds but I still think the direction of travel is lower, in time. This reflects my relative bearishness on growth next year and a more optimistic take on inflation. In relation to high yield, earnings are still holding up well and issuers are doing the right thing through a combination of balance sheet repair and maturity extensions. This is the reason that default rates have defied the market consensus in 2023. There is a word of warning here: the gap between large and small company defaults is rising. Overall, a preference for shorter dated high yield strategies is our theme.

In our Investment Outlook it was interesting to hear Trevor referencing that over 40% of the world’s population will be voting in nationwide elections next year. A focus will be on the US, but old party alignments are breaking down. Gone are the days of fiscal restraint from the Republicans and more tax and spend policies favoured by the Democrats. Both now favour spending, with bill paying kicked down the generational road. Change is more fundamental, though. Economic and societal determinants of voting patterns are changing – witness the Freedom Party’s success in the Netherlands. I see this as a secular shift that will make predicting elections more difficult, as voters focus on values rather than economic self-interest.

US treasury yields were broadly unchanged over the week, with the 10-year ending just above 4.2%. In the UK, rates were lower and we saw the 10-year gilt yield dip below 4% for the first time since May before settling just above. Euro area bond yields mirrored the UK pattern, generally finishing lower on the week. On the currency front we saw a rally in the Japanese yen, following a sustained period of weakness whilst the Japanese bond market gave ground, with the 10-year rate finishing above 0.75%.

Credit markets continued their recent trend of tighter spreads, more noticeable in high yield than investment grade. Sterling issuance is now tailing off and ongoing credit demand may take spreads tighter through the rest of the year. Whilst investment grade spreads still over-compensate for default risk there may be some give back in the new year as issuance and weaker growth prospects are digested.

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