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Buying into bifurcation

1 June 2012 By Robert Cole

When bonds go up, shares go down; and when shares go up, bonds go down. Right? Not recently. Recent moves in the price of assets in these key investment classes suggest that the traditional, binary analysis needs an update.

Look at the last six months in Europe. Euro zone economies have deteriorated. A break up of the single currency, a remote chance last year, is now a worrying possibility. The United States is not booming and growth has slowed in both China and India.

The financial and economic world has become a riskier place. And the downward lurch in yields on top notch bonds suggests investors are very scared. Yet equity markets, while hardly thriving, have held up pretty well. And that is evidence of investment confidence.

Schizophrenia? Not necessarily. The market cannot be deemed dysfunctional just because it is sending different signals. The differing messages sent by different assets may actually be a sign of maturity.

Blown-out spreads between different euro zone sovereign bond yields show that investors are fully aware that Germany is not Spain and Ireland is not Britain. Investors have also driven yields on Danish sovereign bonds – which are safe from the direct risks posed by euro disintegration – below those of even Germany.

Meanwhile different market equity sectors show almost as much yield diversity. European technology shares give a historic yield of 1.9 percent, according to Thomson Reuters data. Telecoms companies, meanwhile, give 7 percent – high enough to rouse more fear than greed.

The variety might be evidence that investors are trying to allocate assets to gain some protection from danger while also getting some exposure to opportunities that could prove profitable if the economic weather improves. It would be sensible to see at least as much safety in the equity of a well-run, lightly geared consumer goods company (Nestle, for example) as in the debt of an over-borrowed, economically sluggish, nation such as the UK.

Different investors, and investors with different mandates, will make different choices. In a healthy market, those different choices can be made at the same time.


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