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Bond of the Week: 3 May 2013

Barclays 7.125% 2049 (perpetual).

    

From Fear to Greed

The old adage that 'there is always a bull market somewhere" has never rang truer. Where, you wonder, is the bull market? Bonds! The three key ingredients to a raging market - monetary easing, ample liquidity, and positive sentiment -  are all present and are driving the bond market into the stratosphere.

Look at the FTSE ORB Index. This index provides a neat summary of the ORB market. (I covered this index earlier this year, see here. Alternatively, you can go to Investec's website here). From 105 in February, the index is now trading above 110 (see below). Strong price momentum suggests that reaching 115 over the summer is not a far-fetched scenario. Many readers who hold some ORB bonds will undoubtedly see profits in their accounts.

As the bond bull roars ahead, value will be difficult to find in the market. Hence, I suggested in last week's Bond of the Week that the preferred investment tactic is momentum. The GE 4.875% 2037 bond, for example, shot up 3 points in just over a week. Other bonds recommended earlier this year rallied even more.

So, which bond will exhibit the greater upward momentum over the next few months? To answer this question, I turned once again to the Sterling Yield Map. This week, I picked the furthest one to the right of the Map - the Barclays 7.125% 2049 (perpetual).

Why this bond? For a few reasons. One, its yield is not too bad at current prices. At 4.7%, the bond's spread versus the 30-year gilt yield is about 160bps. Second, the bond has an embedded call option at par in 2020. Thus, you can view the instrument as a seven-year bond. However, should Barclays decide not to call the bond in 2020, the yield would be re-set to 315bps above 5 year gilt yield, which, in my opinion, is a reasonable spread. Note that the current 5-year gilt yield is about 0.62%. Assuming this level in 2020, the yield on the bond will be 3.77%. The only drawback is that this coupon will be reset every five years.

The last reason for picking this bond is that bank bonds are currently one of the strongest performing sectors in the market. Many have been advancing mightily since 2011 and this bull run is set to persist. This Barclays bond appears to be a near-term laggard and I expect the bond to play catch-up later this year. New highs above 110 should not be too difficult (see below).

Specifics

  • Issuer: Barclays Bank
  • Maturity: callable 24-Oct-2020; then perpetual
  • Coupon: 7.125%; reset to 315bps above 5 year gilt yields in 2020
  • Currency: GBP
  • Rankings: Unsecured, Subordinated
  • Ratings: BBB (S&P); BBB (Fitch)
  • ISIN: XS011893266
  • Yield: 4.695%

View:  A roaring bond bull market is taking place right under our noses. Due to the supply-demand imbalance, most bond yields are now compressed beneath 5%. On the retail-focused sector, nearly all instruments are trading above par, some significantly so. As the market advances, many bonds will undoubtedly see their yields slip further. Once these low hanging fruits are gone, buyers will probably be eyeing corporate bonds within the 4.5-5.0% bracket. I would grab these bonds before the crowd squeezes in.

Dr Jackson Wong

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