JP's Journal: When bad is good

The UK’s reputation has suffered in recent years. Chaotic government, threats to repudiate international treaties, a diminished standing on the world stage – a preeminent 19th / 20th century power living on past glories, mired in nostalgia but unable to learn lessons from history.

We have had a succession of wonderful speakers at our investment conferences over the years – but one really struck a chord with me. His message was that winners should burn their trophies. Past success can lead to complacency, a failure to adapt to new conditions, and a lack of appreciation of how competitors are changing. Unfortunately, Britain has not burned trophies. As a country we have not adapted to the evolving challenges posed by technology, demographic shifts and the opening up of the global economy. We still think and act in a backward-looking way. Perhaps the status quo, of gradual decline, is acceptable because the alternative is too hard or non-viable from an electoral perspective.

The news that Arm, Flutter and CRH are joining the flow of companies potentially decamping from the London Stock Exchange should not surprise. Low price-to-earnings ratios suggest management failure, make acquisitions more difficult and irritate shareholders. As an aside, I have a soft spot for CRH. It was one of my first company visits when I was a junior equity analyst back in the 1980s. I remember that the coach driver got lost and we ended up following a cement mixer back to the plant near Drogheda. Looking it up, I see that the share price was under £2; it closed last Friday above £40, with some nice dividends along the way.

The shrinking of London as a financial centre is not confined to equities. Fair enough, the gilt market has grown and has broadly held onto its weighting in global indices in recent years, but that is only because of bailouts, the covid response and government profligacy. Sterling credit has shrunk too. On a global basis the US dollar market dominates, representing about two-thirds of issuance by value. The euro area has shot ahead of sterling and is now four times larger. The position that sterling had as the ‘go-to’ market for longer debt is over – now all markets compete, across the whole maturity spectrum.

So where is the good news? It is in valuations. Sterling assets are cheap on a global basis. In bond markets it is easy to explain. Issuers go to where the cost of debt is lowest. From a buyer’s perspective you are on the wrong side of this trade. If we look at comparable investment grade indices, we see that the US dollar market is the most expensive with a spread of 1.3%, then comes the euro at 1.5% and sterling at 1.7%. There is variation in composition but the story still holds. It is why our Global Credit strategies are overweight sterling assets.

It was quiet on the data front. However, the trend of higher yields was the main theme for most of the week. This reflected the growing consensus that economic output was holding up better than expected and that further rate rises would be needed to curb underlying inflationary pressures. Yields on 10-year US treasuries went above 4% for the first time this year whilst the German equivalent traded above 2.75%, a 12-year high. The UK reflected these trends with 10-year yields hitting 3.9%. There was a rally last Friday which saw global yields come off their highs but the picture remains of investor unease about latent inflation.

On the theme of inflation, I would point out a recent blog by my colleague Trevor Greetham – you can read this here. In this blog he introduces the concept of 'Spikeflation'. He sees the possibility of inflation falling further through 2024 if high interest rates push major economies into recession, but he does not believe we will get a return to the regime of low, stable inflation that persisted for most of the last 30 years. Rather than Stagflation he sees ‘Spikeflation’, characterised by periodic spikes in inflation on the back of a range of structural drivers, including heightened geopolitical risk, underinvestment in fossil fuel capacity and deglobalisation. Let’s see whether this new terminology catches on, but it reinforces my view that some inflation protection at current real yields makes sense.

On the credit front, investment grade spreads drifted wider as risk assets came under a bit of pressure. Sentiment still remains reasonable and new issues have, generally, had a good response. The highlight last week was a jumbo US dollar offering from HSBC covering both senior and subordinated debt. The former came at a yield above 6% whilst the latter printed at 8%; in total, $9bn was issued although demand exceeded $30bn. High yield markets were stable, and at the index level, credit spreads were lower on the week.

So let me end on the theme of valuation. An article in yesterday’s Sunday Times by Richard Buxton of Jupiter Asset Management highlighted some of the points I have been talking about recently – it’s worth a read, with its focus on the de-rating of UK equities. But the point I would make is one of opportunity. Out of favour investment areas are generally the ones that offer the best value. In my view, sterling investment grade credit is being spurned – and, in consequence, pricing anomalies are evident. Global investing has many merits but make sure you pay the right entry price.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.