Well, last year was far from boring and this year looks like it will turn out to be interesting, to say the least.
Being realistic, very few of us will get rich by investing in bonds but you can use bonds to reduce some of your losses from holding equities. In times of economic uncertainty, as growth slows and equity markets falter, bonds come into their own. The simple fact is that unless you are a very long-term investor, it makes sense to hold a diversified portfolio containing some bonds.
Many point out that you can do just as well in cash. Yes, sometimes that is true but not always and not over the medium to long term. When interest rates are falling, cash gives you less income and no capital appreciation. In contrast, bonds give you the same fixed income and a reasonable chance of capital appreciation.
You will have heard all this a lot recently. Nearly everyone agrees that the Western economies are slowing down and while the US will be worst hit, the key question is how bad will it get in the UK and Europe?
In the US, the news is consistently poor. The housing market continues to be nasty, unemployment has risen to 5 per cent, private sector employment is falling, consumer spending is slowing and there are multiple profit warnings – and not just from the banks. Yes, the Fed has reacted and cut interest rates aggressively and quickly but bond markets are expecting things to get worse before they get better. Two-year US bond yields are down to around 2 per cent.
Will the US go into recession? Maybe not technically but it is starting to feel like one and if it walks like a duck and talks likes a duck, let us call it a duck.
In the UK, we are a bit behind the US but the signs are that the economy is slowing. The effects of the credit crunch are starting to have visible effects on the man in the street. Ask the 160,000 Egg credit card holders who were told last weekend that their funding was being withdrawn. Better still, ask the finance director of any high-street bank which direction their margin is heading in. It did not escape our attention that Nationwide increased its standard variable rate by 0.15 per cent last month.
You should be ready for headlines about inflation, particularly in food and energy prices, but the disposable income squeeze which goes with the current tight monetary policy will have its way and inflation will come down and the Bank of England’s monetary policy committee knows this. There will be scope for the MPC to cut interest rates further and we believe that the UK base rate will go below 5 per cent in the second half of the year.
So it is not all bad news. Central banks will be in a position to stimulate their economies.
Even better, corporate bond spreads are already pricing in a lot of bad news. The yield for the average investment-grade corporate bond is almost 50 per cent higher than the comparable gilt. Banks offer even better value, with AA-rated bank bonds yielding roughly 2 per cent above gilts. At these prices, corporate bonds are offering very good long-term value.
In the very short term, bad news could still be damaging to corporate bonds but, given current prices, the impact is unlikely to be as bad as before. That is why we are not rushing to get back into corporate bonds. Instead, we are easing our way back in over the next few months.
At current prices, I would suggest you look to do the same. After all, bonds offering great value and protection from economic downturn do not come around all that often.
Kevin Telfer is fixed-income product specialist at Aegon Asset Management