Allianz warns on ‘significant’ overvaluation of medium and long-term debt
Allianz Global Investors has warned the mixture of global quantitative easing by governments and risk avoidance by investors has pushed fixed income instruments with medium- to long-term maturities to “significant overvaluation”.
Despite Germany’s only partly successful debt auction last week, AGO says Bunds are “likely to remain safe haven assets for the time being”.
But it then adds: “Even if nominal returns [on sovereign bonds] may turn out to be positive, we expect real, inflation adjusted, returns to be disappointing.”
Andreas Utermann (pictured), global chief investment officer at Allianz Global Investors/RCM, notes bond markets are largely driven by political developments, and “as long as the political uncertainty persists and economic data remains weak, we expect risk aversion to prevail.
“A ‘risk-on’ trade within European bond markets is only likely to start once economic data starts to improve or the European Central Bank takes a more active role in solving the debt crisis.
“As we don’t anticipate a major reversal in the economic newsflow, and as the Fed and the Bank of England may continue to buy bonds again on a large scale, the downside to bond prices in both markets is clearly limited. Bond returns in both markets are likely to be at around the current redemption yield.”
Utermann says the eurozone’s politicians will probably take longer to form and implement plans, aiming to solve the eurozone’s problems, than markets want.
“The longer the debt crisis looms, the bigger the political risk. As the recent developments in Greece show, there is a real threat of a break-up of the eurozone, if political processes get out of control.”
Utermann does not explicitly say the ECB will print money to buy more sovereign debt – it spent over €200bn over 18 months so far – but he expects “a more active and aggressive role for the ECB” in the medium term.
This might help stabilise markets. But Utermann suggests it will not save the real economy from growth rates slower than they were before the crisis.
“We are clearly facing a significant slowdown in economic activity in 2012. The rise in the oil price in the first of half of 2011, tighter monetary policy in emerging markets, and, of course, fiscal tightening in the US and in Europe, is all taking its toll.”
But AGI does not expect most developed economies to fall into recession – real interest rates remain very low, and the private sector is positioned to use cash-flow to spend.
“Our medium term outlook remains unchanged: in times of high public sector debts, and private and public sector deleveraging, trend growth may be lower than before the burst of the bubble. This period is likely to last for several years.”
Against this backdrop, Utermann expects inflation in worryingly indebted countries to remain “within the central banks’ comfort zone’, but for emerging markets’ central banks to move rates to rein in inflation, which is sometimes over 10%.
“Looking ahead we expect rates to start to come down further in the Eurozone whilst emerging markets are likely to continue to reduce rates. In the US and UK, as well as in Japan, we expect the policy of extremely low interest rates to continue into the foreseeable future.”
Coming to the end of a year when US equities fell modestly, Europe’s dropped 20%, and Japan’s declined 17%, Utermann expects little immediate good news.
“Markets are likely to continue to price-in the continuation of the debt crisis for longer. This, per se, also increases the risk of policy failures or electorates may start to question the concept of a European currency union altogether. The most recent developments in Greece and Italy show that this risk is not abstract but very real.
“Against this backdrop, and with economic activity slowing down globally and moderate equity returns, we prefer stocks with relatively high dividends and pay-out ratios. Dividend payments should offer investors some protection in the current environment.
“A lasting rebound in equity markets is expected to take place only if markets can start to price in a credible solution to the EMU debt crisis and/ or when economic data are pointing towards a stabilisation in economic activity.”