Last week's Prime Minister's questions made for interesting viewing They really did let the boom go on for far too long without so much a proverbial quiver of the Governor's eyebrows to alert us to the possible problems ahead.Or, as the Bank's current inflation report puts it: "The longer house-price inflation continues to exceed growth in average household incomes, the greater the risk of a sharp adjustment in house prices and thus to spending further ahead."So the motto for small investors now ought to be "cash is king", and that means paying off those debts. The Governor adds that people must "think carefully" about how much debt they can afford. It is notable that he issued his warning after the Bank last week raised UK interest rates for the first time in nearly four years, to 3.75 per cent.I find it strange that neither he, nor his predecessor Sir Eddie George, or any Government minister said anything like that during the long period when banks, building societies and mortgage brokers would happily lend on sometimes reckless estimates of an individual's earnings potential. Even if you handed the keys back to the building society, they could still come after you for any shortfall in the proceeds when they came to sell the house to recover the remaining loan.These sums could easily run into many tens of thousands of pounds Confidence collapsed until the present boom got under way. Are we due for another crash?The Bank of England, in its teasing way, intimates that such a possibility is not remote. The Governor, Mervyn King, says there is indeed a risk that "heavily-indebted households will be affected by changes in economic circumstances or interest rates". Pretty much anyone who bought property in the boom of the mid-to-late 1980s was caught up in this trap by the early 1990s; about a million households, according to the Prime Minister's soundbites.The price of homes across the land crashed, especially in the South-east, where the inflation had been the most dramatic. Last week's Prime Minister's questions made for interesting viewing. Not only did we have something approaching parity between the two contenders, with two barristers facing each other as Prime Minister and Leader of the Opposition for the first time in history (I think), but we, the watching public, were also reminded of a phrase that may soon enough be making as big a comeback as that of Michael Howard - negative equity. But the longer-term game for bonds will continue to be driven by perceptions of whether the medium- and long-term outlook for inflation remains at, above or below its present levels.The Bank of England, at least, thinks the threat of outright deflation has receded for now, and that in turn suggests the equity market, which is priced to yield just over 3 per cent at present, need not fall that sharply again, at least this year.davisbiz aol . She is clearly right that to make short-term gains from bonds requires careful analysis and nifty footwork.
Ms Zemek's bond fund is up by 10 per cent this year as a result, despite the gloom-mongers' warnings that the climate for corporate bond funds has deteriorated. And the debt overhang implies the recent equity market recovery may be more limited than more bullish observers expect.What lessons can one draw from this? My own comment would be that Ms Zemek's game is primarily a tactical one. Angry shareholders forced a change in management at the proposed ITV merger partners, Carlton and Granada, but in many other cases it is the need to keep bondholders sweet that explains why so many companies are forced to sell assets and repay debt before reinvesting in new growth prospects.As a result, the earnings and interest-rate cover behind corporate bond issues is improving, creating opportunities for price increases, based on an improved credit-risk rating. Which of these three factors is most dominant can change at different stages in the cycle.At present, in Ms Zemek's view, there is an interesting paradox in the corporate bond market. This is that there are interesting opportunities to make money in companies whose balance sheets are relatively weak. In general terms, the present stage of economic recovery differs from many in the past, in that companies in general are still (like the consumer and the Government) more heavily burdened with debt than is typical.This has created a climate in which companies have to pay more attention to the demands of so-called bond-market vigilantes. |
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