Gulf markets were naturally alarmed last week by the ramifications of the Syrian situation and pending international intervention.
At the same time, an element of profit-taking in stocks was present, with analysts referring to the elimination of some speculative froth. Clearly, it was a memo to all concerned that what goes up can come down again, even if the underlying trend is relatively assured.
As to bonds, their fate appears as captured by global benchmarks as has, in some places, been fully foreshadowed. That has made focusing on the policy and economic leadership of the US an imperative for investors.
Sukuk are caught in that pattern too. In that regard, it’s been noted that issuances have waned as the cost of borrowing has risen. Less observed, perhaps, has been the prior point that investors have predictably lost a packet in fixed-income generally.
As Bank Audi nominated in its weekly monitor, “regional bond markets are on a downward streak … tracking rises in US Treasury yields.” Can’t be any plainer than that.
Similarly, research updates by Standard Chartered have asserted that US Treasury yields are the primary driver of emerging market credits, with longer-duration sovereign and quasi-sovereign credits “most at risk, given higher international investor participation”, while shorter instruments “[enjoy] better sponsorship from local investors (primarily regional banks)”.
That said, some recovery is feasible. Ricky Husaini, chief investment officer of investment advisory firm Trading Portfolio, advised clients recently there might be a typical ‘buy the rumour, sell the fact’ story here. “To me, this is an opportunity lurking,” he said, tapping into contrarian knowledge. Even so, he added, “more than ever before, stay nimble and pro-active in allocation strategy”.
These are nervous times. As indicated here last week, there is a further vulnerability implicit in US monetary policy per se, which is truly puzzling. It’s not isolated, either, as the UK has embraced the same thinking.
On both sides of the Atlantic there is disquiet that the long end of the yield curve is not obeying instructions at the short end, namely by the central bank(s).
Rudimentary explanation is in order.
In a nutshell, bond investors are interested essentially in inflation being kept low, as the asset’s income stream is nominal (not inflation-adjusted), and prices move accordingly (i.e. inversely with yields).
So, they prefer restraint of inflation, and slower growth as a proxy for that. Keeping interest rates low for longer, as has been officially promised and underlined, is not particularly welcome.
Admittedly, an offsetting factor would be that the market also values overall policy credibility. The economy needs to grow to some degree, so that political and currency stability are upheld, and demand for Treasuries isn’t overwhelmed by supply as deficits and debts mount.
Yet, the Fed’s gamble seems to be that (a) short-term interest rates necessarily govern long-term interest rates, and (b) the market necessarily agrees with its model of how the economy works. Neither may be true.
If the market accepts that economic growth will improve, then it may assume, unlike the Fed, that inflation will rise too (perhaps earlier). It may reject the conceit that the authorities can ‘fine-tune’ conditions, and inflation can’t exist without the growth that is taking precedence as a priority. Some will remember the 1970s, a critical period of economic history, when stagflation destroyed the academic consensus to which the authorities still seem to be deferring.
In fact, to the extent that bonds retain any buoyancy now, it could be because investors don’t believe the Fed’s strategy for boosting growth will work. (If growth doesn’t rise, then inflation is less likely to rise, and bonds are safer!)
In these circumstances, central banks’ ‘forward guidance’ is not an edict; more like an almighty roll of the dice.
And it really matters. That much has been amply evidenced across emerging markets in the past few months, threatening another debt crisis. In particular, much of the Asian growth miracle has been exposed as essentially a tawdry trick borrowed from the West: merely the momentum induced by relentlessly cheap money.
It’s pretty grim to realise that globally we’re all on another merry-go-round in chasing growth – in terms of volume propulsion rather than value creation -- and so potentially another boom and bust cycle, raising the stakes even further.
Last week I read a fund manager say it was best at this juncture to prepare to lose money. It was not only unusually candid, but an admission that there is no sufficient shelter even in a diversified portfolio, and all asset classes have intermittently to be grounded to reality.
If, as suggested, the world economy is not only weak but weakly managed, then investors have to do really well (in the absence of being able to invest directly on a downturn), to keep their investments afloat.
Events in Gulf bond and stock markets have effectively proven the point.
