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Wednesday, 18 October 2017

On Bunds and value

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Anthony Peters on the magic 1% yield threshold and cheap protection.

Just after 9:00am yesterday morning, London time, the sirens went off, the lights started flashing and the cry went up: “Bunds trading through 1.00%…”.

When New York came in four hours later, the breaching of the magical barrier was headline news, even on the most US-centric of business channels. And yet, the whole show lasted not much more than five or six minutes and by 9:10am the Bund 1.5% 5/2024, the benchmark, was back above 1.00% where it remained for the rest of the day.

It opened this morning at 1.0158%. Now, 0.0158% might not be a lot amongst friends but when it comes to reading the eurozone it makes a big, big difference.

During the course of the morning, I found myself in conversation with one senior portfolio manager at a German insurance group whom I have known for longer than either of us would probably care to admit. Are we really that old? We joked around a bit as we reminisced about his old boss who once declared “Vee buy ze Bund et 6% end vee sell eet again et 4% – simple”. Quite so. In fact, there was one particular insurer, the CIO of which declared that nothing was to be bought with a yield below 6% – we’re talking mid 1990s here – which pushed the portfolio into ever more elaborate structures and which, in due course, cost the man his job and the shareholders their shirts.

My man, on the other hand, was quite sanguine. His division has had a general investment moratorium imposed on it and, unusually for a front-line money manager, he has no problem with the decision. “Why,” he asked me entirely rhetorically, “if I have an investment portfolio of €8bn, which is locked into long term paper at decent rates and with thumping unrealised reserves, should we be panicking over €300mm of cash which is returning only 1% less than 10 year Bunds?”

To be frank, he’s absolutely right. Who has actually sat back and thought about what value really means. To me – and no doubt to him – value is reflected in the fact that at these coupon levels – we’re not that far from zero coupons – small shifts in yield make large shifts in price. The current 10-year Bund with its coupon of 1.50% sports a modified duration of 9.07. That in turn means that a 10bp shift in yield translates into roughly 1 point in price. Therefore, if one buys the bond when the yield is 1%, and that backs up by 10bp, the price drops by 1 point which instantly wipes out a year’s worth of income and in turn pushes the holding into negative total return.

Thus, to my insurance guy and his bosses the 1% yield give-up between cash and the 10-year looks like a jolly cheap protection policy against capital losses. One can’t really disagree, can one? Hence the recurrent argument that cash is burning a hole in investors’ pockets holds only partially true – or at the very least it does in this case.

The rally in Bunds was of course prompted by Germany undershooting the Q2 GDP forecast which had already been for -0.1% QoQ but which reported at -0.2%. That brought then non-seasonally-adjusted YoY figure down to 0.8% from the forecast of 1.3%. The Germans love to seasonally adjust everything including unemployment. I have always had this vision of Hans SixPack turning up at the labour exchange to sign on the dole only to be told that he might be amongst the seasonally-unadjusted unemployed but that, seasonally adjusted, he is not, and that he should kindly go home again and wait until next month in order to find out whether he is unemployed or not. I digress.

The second quarter obviously started on April 1st when the Ukrainian situation, although tense, did not include the exchange of sanctions between Russia and the West. Hence the impact on the German economy will, in the Q2 figures, not account for the full impact. Q3 will therefore surely be even worse and even if the situation eased overnight, which is unlikely, it would take months for trade to normalise. Therefore we can assume that data will remain weak for a while.

August confusion

On the other side of the pond, today brings a raft of data including the Empire State Manufacturing Survey for August, July PPI, July Industrial Production (including Cap Utilisation) as well as the University of Michigan Consumer Confidence survey. St Louis Fed boss Bullard is reported to have spoken of a first increase in rates “as early as end Q1 2015” based on the easing in the labour market and rising inflation. So who really cares about today’s figures?

With America seemingly now pulling one way, Europe the other and the UK not knowing which way to jump, risk markets have a good reason not to know what to do.

It’s Friday, it’s August… best do nothing.

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Alas, it’s that time of the week again. All that remains is for me to wish you and yours a happy and peaceful week-end. Schools will be back in business soon so it will be off the Asda (that’s our UK incarnation of Wal-Mart) where one can buy a complete school uniform for the cost of a Starbucks Vento cappuccino with an extra shot. All it then takes is couple of pens and pencils from the stationery cupboard at the office and it’s job done… Bring on the cricket.

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