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When global bonds perform well

Jardine Fleming explains why it thinks global bonds will continue to do well.

Sunday, November 29th 1998, 12:00AM

by Philip Macalister

Most people agree that the current economic environment is one of uncertainty. However, it is worth remembering that international bonds generally perform well during uncertain times. Consequently we believe that the outlook for bonds remains positive even though this asset class has provided worthwhile returns to investors over the past year.


Why do we have this view? Two of the main factors influencing global bond returns are growth and inflation, both of which as we will see below, are subdued or even negative.

The Asian Crisis which began mid-1997 has curtailed growth in much of the world. Substantial overcapacity and lower commodity prices feature almost everywhere. Consensus figures for world GDP growth have been revised downwards. Here in New Zealand the question currently is whether we will experience a third quarter of negative growth.

Central banks, traditionally the protectors against inflation, are becoming more concerned about the possibility of deflation, and we’ve already seen interest rate cuts in the US as well as in parts of Europe.

During the 1970’s and early 1980’s many had savings eroded due to high levels of inflation. In fact, average inflation in the industrialised nations of the world reached around 14% due to the oil shocks. Today’s scenario is of an environment where inflation of between 2-4% is the norm; much like that of the 1950’s and 60’s. During these times of low growth and low inflation both bonds and equities performed well for investors.

Inflation in the Industrialised Countries: Back to the 1960s

In the US, the fact that the Federal Reserve has cut interest rates three times in as many months is a strong indication that the Fed still has a bias towards easing. Europe, while not insulated from global problems, should still grow faster than the US or Japan in 1999. However, inflation should not be a problem (at around 1% and heading lower) as unemployment in Germany and France is above 10%.

The country contributing to much of the world’s uncertainty is Japan. With a banking sector full of problems, Japan’s credit crunch is in full swing; this has resulted in the largest drop in bank lending ever, and the highest levels of bankruptcy since the early 1990s. Anecdotally, the best selling consumer product in Japan is the personal safe: savings are literally going under the mattress.

The upshot of this low growth, low inflation backdrop is that real yields (ie. nominal yields minus inflation) look attractive. As we mentioned earlier, bonds generally perform well during periods of low growth and low inflation, and as part of a well-diversified investment portfolio should continue to add value for investors.

Commentary supplied by Jardine Fleming NZ Management Ltd, part of Fleming Asset Management, based on information from Flemings. 25 November 1998

Neither Jardine Fleming nor the Trustee nor any other person guarantees the performance of the Fund, the return of capital or any particular rate of return for investors. Investors are reminded that past performance is not necessarily a guide to the future. The value of investments and the income from them may fluctuate and your investment is not guaranteed. Exchange rate movements may cause the value of underlying overseas investments to go down or up. Any forecasts or opinions expressed are Flemings’ own at the date of this document and may be subject to change.

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