Artemis’ Snowden: The bond market has passed ‘peak fear’

The Artemis Corporate Bond Fund manager recommends a corporate bond yield of 6% to beat inflation in the medium to long term.

The UK bond market has already bottomed out, with interest rates higher in this tightening cycle than they’ve already been priced in, according to Stephen Snowden, Artemis Corporate Bond Fund Manager.

In a recent article on Trustnet, Bruce Stout of Murray International said stock markets have yet to reach a “fear peak”, as we haven’t seen any forced selling.

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However, Snowden claimed it’s a different story in the UK’s fixed income market, where the FTSE Actuaries UK Conventional Gilts All Stocks index is up 14.3% since the height of the panic over ex-adviser Kwasi Quarting’s disastrous mini-balance sheet.

Index performance in 2022

Source: FE Analytics

When asked if he felt that fixed income in the UK in general had already passed the ‘peak of fear’, he replied: ‘Yes, the easy answer would be. Obviously the peak of cheapness achieved because of the great economic and political uncertainty that we were in six years ago. Weeks are over, and the markets are much more reassured by Rishi Sunak and Jeremy Hunt.

“But I personally don’t think the base rate increases that the market has priced in will be delivered.”

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The main reason Snowden says bond yields are excessive is due to the inability of UK homeowners to deal with higher rates. While only 20% of mortgage holders are currently on variable rates, another 30% are on fixed-rate contracts that will expire before the start of 2024.

Data from Moneyfacts showed that the average five-year mortgage rate has risen from 2.3% to just under 6% over the past year.

“When you’re in a highly indebted society, both on a personal level and on a government level, the economy is more sensitive to interest rates, and that’s why we think we’re going to see a material impact on economic growth and consumer confidence long before we hit the peak of what’s been priced in,” Snowden added.

He also expected inflation to drop significantly in the next year or so. While the CPI recently reached 11.1% for the first time since 1981, the Office for Budget Responsibility has claimed that the UK could enter a period of deflation by 2024.

Snowden was skeptical the drop could be that severe, but said it would be prudent to stabilize yields at their current levels, especially in corporate bonds where they are particularly high.

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Inflation today is 11% but I think it will drop to around 3% in a few years and we are heading now [corporate bond yields of] 6%. While they don’t compensate you for inflation in the next 12 months, they should compensate you handsomely for years after that,” he said.

“The average life of UK corporate bonds is nine and a half years, so if you buy now, you have nine years of this very high income which will, on average, vastly exceed what inflation has to offer.”

Snowden acknowledged there were still risks in corporate bonds, but said he couldn’t think of a better alternative to defeating inflation based on the rate of risk. The manager agreed that stocks can underperform when the market turns, but noted that corporate bond yields are much higher than dividends, which is another tailwind for the asset class.

He continued, “When yields were high in previous decades, people bought bonds, but we see fewer companies issuing them.”

“When your dividend yield is materially higher than your company’s bond yield, it makes sense to issue bonds, buy back shares, or pay dividends because your financing cost is cheap, but now the opposite is true.

“I’m not saying companies will stop buying stock or paying dividends or investing in plant equipment, but the hurdle rate to get over it is now much higher.”

“As a result, we have more demand for corporate bonds and less supply, and that’s a very healthy backdrop for returns in the medium to long term,” he added.

Corporate bond managers like Snowden are expected to talk about the prospects for their asset class, but others without a vested interest are similarly optimistic.

Guy Monson, chief market strategist at Sarasin & Partners, said: “We see growing value in UK investment grade corporate bonds, particularly from issuers in less cyclical or global industries. Yes, we expect a recession in the UK, but we think it will be Moderate—particularly with energy price fixing, employment strength, and savings strength.”

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