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Bond of the Week: 26 April 2013

General Electric Capital 4.875% 2037 - XS0229561831


Value or momentum? That’s the question I ask myself when analysing the current bond market. After a multi-decade bull run, fixed income instruments are undoubtedly richly valued – particularly government gilts. But this does not mean the bond market will immediately collapse. As far as the current economic picture is concerned, it is possible that the UK gilt market may repeat the experience of Japanese Government Bonds (JGBs) - where bond prices stay high for a generation. Even the bond king recently quipped: “I don’t see a bond bear market on the horizon until this magical potion of cheque writing and policy rate stabilisation creates some type of nominal growth.”   (See here)

In a recognised bull market, ‘value’ will be hard to find. This is because every investor is aware that prices are, by and large, going up and will bid aggressively on setbacks. The “buy the dips” mentality dictates that value will not linger.

A quick look at the Sterling Yield Map (a feature available here) confirms this observation. The number of Sterling bonds now offering 5% yield is thinning. Outside 2023, virtually all bonds are now trading sub-5%. The only long-maturity bond still offering 5.3% yield is the Italian 2028 bond. (But I was told the liquidity on this security is sparse.) And when I look back at some of my recent bond recommendations, many of them have done well, which suggests to me that, one, the bond bull is raging ahead, and two, the ‘hunt for yield’ theme is very much in motion. The HSBC 2033 issue, for example, is trading seven points higher since February (see the BoW commentary here). Even the Segro 2035 bond, highlighted just a few weeks ago, had surged four to five points (see BoW here and the chart below. The red arrows indicate the time I covered the bond in the Bond of the Week). ORB-born retails bonds ICG 2020 and Unite 2020 have also advanced strongly of late.  

So, here lies the quandary. As gilt yields sink, it is dragging the entire yield curve lower. In this environment, it will be difficult to buy bonds that are offering the same high yield as before - unless the spread widens. Hence, I guess the better tactic now is to focus more on momentum than value. Along this line of thinking, I highlight the General Electric Capital 4.875% 2037 bond.

First to note is that this bond has about 24 years left to maturity, a long duration bond. According to its specification, the bond contains no option to call. Secondly, this bond is backed by GE Capital, a subsidiary of the conglomerate General Electric. The profit generator of GE Capital is loans and leases across a number of sectors (see their website here).

The third, and most important point, is that the bond recently advanced above par. At 103.4, this is a new price high, indicating strong upward price momentum (see below). Currently, the bond yields about 4.6%, which is not too bad considering the size of the firm and the quality of its operations. The bond is rated AA by Standard & Poor’s and A2 by Moody’s, which, in my opinion, suggests a reasonably strong entity. The bond’s spread versus the 20+ gilt yield is about 200bps – not as wide as 7-year ORB retail bonds, but still attractive enough.  

View: With the masses continuing to flock into bonds, this bond could be an interesting pick. At today’s price, I would not define the GE Capital bond as a ‘value’ buy. (100% appreciation in four years is a big advance.) Rather, I am more interested in its bullish price momentum. The yield target for this bond is 3.75%-4.00%, about 65bps-90bps beneath current levels. Of course, there are risks to this trade. The first is that gilt yields may rebound in 3Q. Second, the bond may trade sideways for an extended period of time, like it did during 2010-2012. Third, the bond just rallied a chunky nine points from its February lows. A price correction may occur. So, I would probably wait for a minor pullback to buy.        

Dr Jackson Wong

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