The collective sigh of relief from governments and households around the world was an audible soundtrack to the rollout of a vaccine for Covid-19 last week. The rapid development and trial of a range of new vaccines has been rightly hailed as a triumph for medical science. In many quarters some concerns remain around the speed of the deployment for these vaccines, but after months of lockdown restrictions and the significant damage wrought on the global economy, the majority of citizens are delighted to welcome what feels like the beginning of the end of the pandemic’s devasting effect on the global community.

Risk markets have also celebrated the news, despite large swathes of Western developed market economies still under very restrictive measures to contain the virus. Economic data for the fourth quarter in most of these economies are likely to reflect the continued lack of normal levels of household spending and activity, but markets are looking through this period to the brighter days of spring and summer of 2021 and the anticipated vigorous economic recovery on the back of a wide ranging inoculation programme.

Many global stock markets are making new all-time highs, investment grade corporate spreads are back to or close to their Jan – Feb 2020 tightest levels and even high yield markets are within touching distance of the tighter levels seen in the first couple of months of this year. Everything in the garden is rosy!
If this year has taught us anything it is that financial markets and economies will be subject to a lot more bumps in the road than we can ever appreciate or forecast. Being mindful of the unexpected around your core view is a prudent way to run investment risk.
With the vaccine roll-out having started, governments will be keen to maintain accommodative policy measures well into any recovery and central banks are likely to keep monetary policy at exceptionally loose levels while also supporting credit markets; in this context, the outlook does look positive for credit markets as a core view, despite the current elevated valuations.
As always though it is those tail risks that keep fund managers awake at night. The possibility, that for unforeseen reasons, the positive economic outlook and recovery is in some way derailed. With credit spreads towards the expensive end of their historic range, a prudent risk aware portfolio should have some form of hedge in place to mitigate against these possible outcomes. Despite the very low level of government bond yields, the early days of the Coronavirus crisis showed that if risk assets sell-off then the best hedge against that move is to own developed market government bonds.
This is exactly the barbell strategy the Jupiter Dynamic Bond team has been using for some time and one that has served the strategy well as the crisis developed and the recovery plays out: on the one hand a long credit book focused on specific non-cyclical sectors and within those sectors the best managed names that can deliver good revenue flows through the crisis and beyond into the recovery; on the other hand, to offer risk protection to the portfolio, there is a significant allocation to developed market government bonds to protect the fund from those tail risk events.
However, the developed market government bond position is not included just as a risk hedge against a non-optimal outcome for the global economy. All the macro economic trends that had been driving global yields lower over the last few years have only been accelerated by the pandemic. The aging demographic of developed economies will continue into the foreseeable future, a trend that has had such a powerful influence on global yield levels:
Demographics is destiny
World’s largest economies (30 year yield versus median age)
Demographics is destiny World’s largest economies (30 year yield versus median age)
Source: Bloomberg. Data as at 3rd September 2020.
The chart above highlights the significant correlation between a population’s median age and its long-dated yield levels. This is also not purely a problem for the older western economies; we can see similar trends in China and Russia and there is no reason to believe that this relationship will not hold across multiple economic regions. Global yield levels are set to compress further under the power of these demographic problems, but also as the elevated levels of global government and corporate debt create a significant headwind for the global economy in a post-Covid recovery. Add to this mix the disrupting effect of ongoing technological innovation and advances in artificial intelligence and we struggle to see where the significant inflation boost and associated rise in core bond yields, that so many market participants are talking about, will emanate from!