Bond Outlook December 7th

A useful expression seems to have migrated from the building industry, through IT to micro-economics in general: the platform company. The term has been boosted by its adoption by GaveKal in their review of economic developments, "Brave New World", and helps explain why the debt-based spending by the USA has not yet proven so unsustainable as we and many others have supposed. We hope eventually to compare and contrast the GaveKal view with the opposing one found in "Empire of Debt" by Bill Bonner.

In the meantime, the platform company concept (companies in the advanced economies, especially in the USA, designing and selling, but subcontracting manufacture to Asia) helps explain:

• high profits of US companies combined with the massive national current account deficit
• low profits of Asian companies combined with a massive current account surplus
• the attractiveness of US assets leading to a capital counterflow sufficient to offset the current account deficit - so far, at least
• the stifling of "creative destruction" à la Schumpeter in countries like France, Germany and Italy where failing enterprises and industrial activities are kept alive by protectionism and subsidy, resulting, paradoxically, in high unemployment
• the shift in relative prices, with manufactured goods getting cheaper, services and limited assets getting dearer, even much dearer
• greater job security, two-spouse incomes and lower volatility in interest rates encouraging (even justifying) both the rise in US house prices and the debt-based household spending
• huge liquidities looking for a home precisely when platform companies need less capital.

Most importantly for fixed-income investors, these phenomena have led and will continue to lead to low inflation and low bond yields. This state of affairs does indeed depend on dollar surpluses in Asia and OPEC finding their way back to the USA, be it from central banks under political orders or from private investors simply feeling safe with US assets. Our earlier fears that the Asians would soon tire of recycling dollars to the USA have proven overdone or premature. So let us assume continuity of the status quo for many months, at the least. That would imply that the US yield curve, now almost flat, will long remain that way. Rather than wait till the last apparent Fed hike, we are therefore ready to move out on the yield curve to a neutral position of 5 years average maturity, while supposing that the Fed will refrain from lifting rates all the way to 5% lest it causes serious curve inversion.

In the UK, the choice of the Tory Party of young blood over experience gives them a better chance of returning to power. Just what real policies emerge from Cameron, beyond having more female MPs, will be worth watching. Brown is likely to realise that he has gone as far as he dare with tax increases, both because of the Conservative alternative and because he, too, recognises that the heavy social charges and taxes in Euroland act as a barrier to the entrepreneurial activity which has stood the UK in relatively good stead in recent years.

Fitch has downgraded Hungary but with only modest impact on the currency and yields. Overall, the entry of the former communist countries to the European Union provides the opportunity to Western Europe of developing "platform companies" within the EU itself. German companies have grasped this opportunity well, much to the dismay of trade unions in that country, and despite, rather than because of, Government policy. Many other examples of intra-EU "platforming" are given in the current Business Week.

"Platforming" certainly seems the way to go in advanced economies, but we suspect that the USA has taken it to dangerous extremes, especially in allowing so much debt at national and household levels. Euroland may have an advantage in not having relied on debt for household spending, although it may have erred in the opposite direction.

Recommended average maturity for bonds in each currency

Barbell in EUR. Move to a neutral 5 year in USD.