Time to take bonds seriously
Summer is very much in the air. Country by country and region by region, schools will be closing for the long summer holidays and trading floors will begin to depopulate. We are also in the last week of H1/2023, so books will be in the process of being bedded down ahead of gradual decline in market liquidity. Overall, its not been a bad six months for equity investors. Although most major indices are a bit away from their 12 month top, they have at least defied the most dire of predictions and are, were one to generalise, a lot closer to the high than to the low. The most notable outlier is the FTSE which at last night’s close of 7,453.58 pts is as close to being half way between the two – 6,707.46 pts and 8,047.10 pts – as is possible. I guess at the other end of the spectrum lies the flying Nasdaq at 13,335.78 pts against a 12 months range of 10,088.83 and 13,864.06 pts.
Central banks have been merrily tightening monetary policy and although their reference rates have been steadily going higher, longer dated bonds have not followed the lead and yield curves remain strongly inverted. Headline inflation is beginning to come lower although all around core inflation remains sticky. For the first time in many years, the front end of the bond markets, or at least those of the US and the UK, are looking as compelling to investors as they are to traders.
As half year end approaches, I am also preparing for my quarterly investment committee meeting which I will not be attending in London in suit and tie but will be tuning into remotely from deep in the Scottish countryside. As ever, we have had preliminary discussions and I have expressed my view that although the risks of a recession remain significant, equites are not yet ready to go screaming for the hills but that I also believe that the time has come to take front end bonds seriously and not just to hold them in the smallest possible way required in order to remain within the strategic asset allocation guidelines.
The commercial real estate thing, however, hangs like a cloud over diversified portfolios . While residential rental rates have stayed firm and in most parts look as though they might strengthen further, the lot of commercial space is looking worse. Residential estate agents – that’s realtors to the transatlantic cousins – are trying to keep smiling while endeavouring to encourage sellers to beat the ongoing decline in prices by accepting offers below their expectations on the basis that one bird in the hand is better than two in the bush. One of the recurring features of declining housing market is that putative buyers are happy to settle in rented accommodation, pending lower prices. Bingo! But the commercial sector trades by different dynamics. Large chunks of illiquid assets can unproductively and expensively hang around for many years.
As the legendary Reichmann brothers would be able to confirm, there is nothing as useless as a once prestigious office block which has passed its first flush of youth and which has been jilted by its tenants for a newer, sharper property. News broke yesterday, that HSBC is to desert its Canary Wharf headquarters for a smaller building back within the City. I used to work in the building next to 8 Canada Square and it is not easy to get one’s head around the thought of Honkers and Shankers leaving the Wharf and moving back to the City. It is apparently planning to relocate in 2026 to the old BT building next to St Paul’s cathedral. The City has long been in decline and the list of major firms which remained there and did not join the migration to Canary Wharf is remarkably short. Goldman Sachs, Deutsche Bank, UBS and Nomura were amongst the biggest names to have remained in the Square Mile and the thought of HSBC moving back will rattle the London office sector. More to the point, what to do with an empty, currently 20 year old 45 storey tower? Sprucing it up and repurposing it will not be for the faint of heart or weak of cash flow.
I guess it must be the better part of 50 years ago that a poster was on sale which depicted an entirely deserted downtown Manhattan with dinosaurs roaming the streets. My own home town of Oldham to the north east of Manchester was once “Cottonopolis” and where in 1909 in the one town more cotton was being spun that in Germany and France put together. Today it is pretty much a wasteland and by all accounts the most derived conurbation in the country. Not that I’d want to cast aspersions in the general direction of Canary Wharf although the entire area, one of the most complete banking ecosystems on the planet, is itself the product of repurposing. The name Canary Wharf dates back to the heyday of the Port of London when it was here that fruit and vegetable from the Canary Islands, and other overseas fresh food supplying nations, were landed.
Commercial real estate of course encompasses a lot more than just city centre office blocks and as miserable as the outlook would appear to be in that space, warehousing and distribution centres remain well bid, albeit that the cost of funding has shot up and many over-leverage spec developers are finding themselves on fairly thin ice. If I were a lending banker, I know which one I’d feel less worried about having to repossess.
Markets have taken a remarkably pragmatic view of events in Russia. Vlad the Invader, instead of getting his story out there, hung around for three days and then produced a transmission to the people of Russia so full of platitudes that it could have been written by ChatGPT or, in his case ЦхатГПТ . He was of course pretty quick out of the blocks in blaming Ukraine and the West for having triggered the revolt. Whether the people who before the weekend had given him an 80% approval rating will be as dubious as we are is a different matter entirely. What the result will be in terns of renewing the marine agreements for the shipping of Ukrainian cereals across the Black Sea will have to be seen. Putin needs to visibly burnish his hard man image and those who over here were dancing in the aisles in the face of the Wagner guys going rogue might yet live to rue their approval. Putin seems, or so it appeared to me, to have already retracted his offer of impunity to the Wagner fighters and has made it conditional on them bowing down and paying homage, something from which they had previously been expressly excused.
Where markets will go from here remains the great mystery. On one hand there is the recession argument which some assume to spell trouble for risk assets while on the other hand, however, the argument remains strong that some pretty significant chunks of cash have been kept in defensive positions and that, having missed the positive outcome of the first six months of the year, will be looking for a chance to catch up. I have my doubts. Markets don’t just go up by osmosis; they go up because there are more buyers than sellers. No market has ever drifted upwards. They are subject to the laws of gravity and will always drift lower until they find buyers. So when markets are strong and remain strong, the argument that big money is side-lined or hiding lacks credibility. Private wealth might be defensively positioned but widespread assertions that institutions are underinvested and dancing around their handbags do, from where I am looking, not appear sound.
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