Shares: Gilt-edged chance for investors
Sunday 07 March 1993
I believe that is the case and also that yields may move sharply lower after what I expect to be a good Budget for gilts, so investors who agree with me need to act quickly.
My speciality is share selections - although I did recommend buying gilts last August when yields were well over 9 per cent - but I am returning to the subject because I see a major investment opportunity. I also think the bull market for bonds now raging across the world is an early indicator of a massive global equity boom.
Many readers may find gilts a complex investment. My preference is to go for a stock that is not going to be redeemed for a long time and where the price is close to par or 100. This makes 8 per cent 2009 a good choice, priced at pounds 9711 16 currently. The running yield (what you are paid each year in interest) is 8.19 per cent. The yield to redemption is slightly higher at 8.25 per cent. If yields fall as I expect, the price will rise sharply, creating the potential for a large tax-free capital gain.
An ingenious strategy put forward by Michael Hughes, a gilts expert at BZW, is to buy gilts with different interest due dates - so a payment is received every month - and spend the money on shares.
Roger Bootle, the Midland Montagu economist, tells me that two years ago he came up with 'Bootle's Vital Statistics for the 1990s'. These are three, six and seven - the numbers he expected to be achieved for inflation, base rates and bond yields respectively. Since the latest figures for inflation and base rates were 1.7 and 6 per cent respectively, it is not surprising he is still keen on gilts.
His argument is that we are now returning to a low-inflation normality. Gilt yields soared in the 1970s when inflation was pushed up by two oil price explosions and the end of the 1960s Bretton Woods era, when the dollar link with gold was abandoned. In the 1980s, asset price inflation encouraged the reckless borrowing that is now being unwound so painfully. These aberrations, as Mr Bootle describes them, are now behind us and gilt yields could fall a long way. In the 1930s, they virtually disappeared, and after the war in the most famous 'cheap money' era, the government was issuing stocks with 2.5 and 3.0 per cent coupons.
The bond bull market is a worldwide phenomenon. In Japan, long bond yields have dropped below 4 per cent and could go close to 3 per cent. In the US, the proposals for cutting the deficit have sent bond prices soaring and yields tumbling below 7 per cent. Even in Germany, yields have dropped from more than 9 per cent to under 7 per cent. If German and other continental interest rates fall sharply, that should keep yields heading down. A major factor keeping bond yields high has been soaring government borrowing. But it now seems the fears have been overdone, particularly in the UK. Recent figures have caused economists to scale down their forecasts for the PSBR. If, as widely expected, the Government uses the Budget to state that buying of gilts by banks and building societies will not be offset by sales of gilts to non-financial institutions, James Capel economists say required gilt sales in 1993-94 may be no higher than 1992-93 levels.
There are plenty of reasons for being bearish on gilts and Chris Anthony at UBS Phillips & Drew talks of yields back up to 9 per cent by the year end. But they would be much lower now if there were no bears.
One simple pointer to the scope for yields to fall is a chart of the inflation-adjusted yield on 2.5 per cent Consols. The latest real return of nearly 7 per cent is almost certainly a post- war record. Something has to give - either yields must fall or inflation is about to take off. I don't believe the latter, which makes me a super-bull on gilts.
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