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26 May 2016

Japanese & German governments should take as much money as they can and spend it

Nigel Thomas, manager of the AXA Framlington UK Select Opportunities fund

“If I offered you £100 and said just give me back £99, you would probably say thank you very much. If I continued to do it, you would keep doing it and eventually, you would spend some of it.”

These were the words of Simon Bond, of Redburn Research, who wrote a piece called “Nonsenses” in March 2016, with regard to the negative redemption yields on some German and Japanese government bonds.

Nigel Thomas, manager of Elite Rated AXA Framlington UK Select Opportunities fund, brought this to our attention in his latest note to investors. He pointed out that the Japanese and German governments are currently being given the same opportunity by markets, so they too should take as much money as they can and spend it.

What are negative interest rates?

Nigel commented: “If quantitative easing and monetary policy has gone as far as it can in the developed economies, then surely fiscal stimulus should now be the major policy tool? Even if you look at the 20-year bonds in Japan and Germany, their implied cost of borrowing (given their low yields) is approximately 0.5%. Why should we not see a massive increase in infrastructure investment, a new Marshall Plan across Europe, to build new roads, rural broadband, high speed railways, hospitals, ports, runways, etc.? This infrastructure would not only be a stimulus to growth, but would in due course help productivity.

“It is not only the government bond markets where bizarre things are happening, look at corporate bonds too. Sanofi S.A., the French pharmaceutical company, on 19 March 2016 announced a fixed rate note (debt that pays the same amount of interest until maturity) issue of €1.8 billion in three tranches with varying maturity dates. These notes were “successfully priced” and if I was a corporate treasurer, I too would issue 12-year corporate bonds at 1.125% while the window was open, and sit back and enjoy. The 0.000% floating rate notes opened just below par at €99.979 and are redeemed at par on 4 May 2019 – doesn’t seem a great return to us. This compares with Sanofi S.A. equity dividend yield for 2016 of 4.0%. Quelle absurdité.

“Let us return to equities, where it has also not been a bed of roses. Amec Foster Wheeler (no longer FTSE 100), Anglo American, Antofagasta, Barclays, BHP Billiton, Centrica, Glencore, Morrisons Supermarkets, Rio Tinto, Rolls Royce, Sainsbury’s, Severn Trent, Standard Chartered and Tesco have all recently cut (or confirmed that they will cut) annual dividends.

“There are some similar trends here - deflation of energy and commodity prices and deflation of food prices. A great deal of uncertainty persists with slower global growth, compounded in the UK in the short term by ‘Brexit’ (Britain’s potential exit from the EU). If deflation gets stronger and investment decisions are delayed, negative rates could slow growth further by way of increased savings.

“We will endeavour to find good companies that convert a great deal of their profits into cash to continue paying ordinary and sometimes special dividends. Although cyclical companies will have their day in the sun, we believe it is the growing companies that will increase their shareholder returns over the long term.”

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Nigel's views are his own and do not constitute financial advice.

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