The case for bond buying – Westhouse Securities


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By Simon Pettitt, head of fixed income at Westhouse Securities

On a cold January morning, a young man called Joshua Bell sat in a Washington DC metro station and played his violin during 45 minutes of the rush hour commute. He played six Bach pieces, one of them the most intricate pieces ever written for violin.

It is estimated 1,100 people hurried past him to work, 20 gave him money – he earned $32 – and six people stopped to listen. During this time, there was no applause, and when he was finished there was silence and no recognition of him having been there at all.

Bell is one of the most talented violinists on the planet – Google him. The violin he played that day is worth $3.5 million and two days previously he had sold out a Boston theatre at $100 a ticket.

The busking was organized by the Washington Post as a social experiment about the public’s perception, taste and priorities. The questions were: do we stop to appreciate quality; do we recognize talent in an unexpected context; and, if we don’t have a moment to stop and listen to one of the best musicians in the world playing the best music ever written, how many other things are we missing?

Simon Pettitt, head of fixed income at Westhouse Securities
So, here is some stuff you might have missed in your daily financial hubbub.

Japan will buy bonds issued by the European Stability Mechanism and denominated sovereign debt, a strategy that finance minister Taro Aso said will help weaken the yen and support Europe. This means that sensible people – other than European banks – are willing to believe in the European solution and put their money where their mouths are. This is in addition to the evidence for American institutions buying Italian bonds that we saw at the end of last year. It’s not just a bunch of staggering drunks leaning on each other for support any more. Some semi-sober guys are staying on their feet unaided.

Ireland at last revisited the bond market on Tuesday by tapping the 5.5% October 2017 bonds to the tune of €2.5 billion. This was immediately followed by a €1 bill Bank of Ireland 3.5 year tier 2 deal in CoCo format. This is cash demand led. They’re back... to be sure, to be sure...

In 2011, only six sovereign states had 10-year maturity bonds yielding just 2% or less. In January, this has grown to 15 sovereign states, including some surprising names: Czech Republic, Singapore, Taiwan and Hong Kong.

Nigerian government 2021 bonds denominated in US dollars are yielding 3.7% on the offer side – but this is 185 basis points more than equivalent US treasury bonds – real yields are negative here. They were at 6% in January 2012. It has been a one-way street. Which way will they go this year? Would you buck this trend?

With two of the biggest central banks in the world – the Fed and ECB – having the biggest skinny in the game ever, a small movement in yields makes a huge difference. The dollar value of a 1bp movement in the Fed’s balance sheet is now an extremely large number that knocks austerity cost-cutting numbers into a cocked hat.

Are you a stock market bull? BlackRock’s Laurence D Fink, who heads the world’s largest asset manager, tempered his optimism for the stock market in the first quarter after saying he’s disappointed by the bill US lawmakers passed to avert spending cuts and tax increases.

“I look at this as a very bad warning sign.” He said he would buy bonds, while being more cautious on equities in the short term. Meanwhile, the Russell 1000 equity index has climbed to 810.48, which is almost the all-time high – in September 2007, just before the financial crisis started to bite – of 852.32. Are earnings going to be that good?

The Spanish government today auctioned bonds in three tranches, targeted €4 billion to €5 billion in total size. The results were staggering, with €5.82 billion actually sold, all tranches at least two times covered and the old Spanish 10-year government bond actually tightened 6bp this morning in the face of all this supply.

In the Italian bond market, since August 2011, the Italian 10-year bond has gone up 13.3 points – a 13.7% price increase. Italy just auctioned €8.5 billion 12-month T-bills at 59bp tighter spread than the last auction, saving a relative €50 million in interest payments. The inclusion of the letters S (Spain) and I (Italy) in the word Pigs to describe these peripheral bonds is looking a bit silly now...

Final story... UK’s Prudential issued a $700 million new perpetual tier 1 bond deal on Tuesday. Originally, the pricing talk was 6% yield. The subscription book grew to $10 billion – ie 14 times done. As a result, the pricing talk tightened to 5.5% yield. The subscription book then grew to $15 billion – ie 21 times done. The bonds were finally priced at 100 with a 5.25% coupon – ie 75bp tighter than the original price talk.

The market is currently bid at 100.25, having been as high as 100.5 bid – even after the tightening, etc. 100.25 is equivalent to a yield of 5.22%. You gotta love financial subordinated debt...

I’m not so sure that stories about bucket-loads of real money cash coming out of bonds into equities this month are terribly well informed... Is that a violin I hear or just background noise?