A few months ago we remarked that credit markets were very boring. US credit markets were displaying late cycle behavior, M&A activity was high and it was not an environment in which credit investors were getting well rewarded.

 

 

We had, however, a growing niggle that global bond yields may keep falling against all the mainstream consensual thinking. Our main concern was, and indeed still is, the dismal global growth we have experienced post the Global Financial Crisis.

 

 

In 2010 we went short duration in our portfolios partly due to overconfidence after a rather successful credit crisis, but also partially blinded by our orthodox university training in the science of economics. It was after reading Richard Koo’s book in 2011 that we completed a volte-face in our duration thinking. Koo is highly critical of the economics profession as it completely ignores “behavioral” responses to traumatic events. He introduced the phrase “balance sheet recession” and predicted that Europe would turn “Japanese” nearly six years ago—frankly, he has nailed it. We have also long been big fans of Larry Summers’ “secular stagnation” theme; now Brexit has exaggerated this view.

 

 

Thus, our macro outlook remains realistic but fairly dismal regarding growth and inflation. Aside from the impact from Brexit, we have serious concerns about falling Japanese bond yields, the strength of the yen and the almost inevitable threat of a Chinese devaluation, which will bring yet another wave of deflation.

 

 

Bond returns will be all about “income” in the future, and we intend to lock this in for as long as possible for our investors. We expect bond yields in the US and the UK to fall further and their yield curves to flatten even more as European, Japanese and Asian investors seek out yield. We expect investment grade bonds to “party on” as the global grab for yield continues.

 

*Brexit: UK’s decision to leave the European Union.

 

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