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Bonds
March 2019
Bond Rally Continues
We have increased our position in emerging market investment grade bonds to neutral from underweight to reflect our expectations of a catch-up in emerging market assets’ performance as China’s growth stabilises.Global Credit markets are off to their best start to the year since 2012 with Emerging Market Credit up 3.6 per cent, U.S. High Yield up 6.3 per cent and U.S. Investment Grade up 2.3 per cent. Within Emerging Markets, High Yield is up 5 per cent while Investment Grade has risen a more than respectable 2.7 per cent.
Remain constructive on Emerging Market bonds
The recent Fed pivot toward a more dovish stance, emphasising patience on rates and more balance sheet flexibility, removes the major structural headwind facing global Credit markets including Emerging Markets. As such, we remain constructive on the asset class over the coming months.
A tepid U.S. dollar and rising commodity and oil prices have enhanced the positive macro backdrop. Bottom up company fundamentals remain supportive with improving balance sheets in recent quarters and a “distress” ratio that portends modest default rates going forward. While the market has exhibited a strong rally in recent weeks, spreads remain well above 2018 tights. Finally, technical, have turned supportive with record asset class inflows and new issuance projected to be lower this year versus 2018
Overweight position in EM HY and neutral stance in EM IG bonds
We continue to recommend an overweight position in EM HY and upgrade our stance on Investment Grade to neutral. Our view is based on the following factors:
1) EM High Yield is more attractive on a valuation basis versus comparably rated U.S. credits than EM Investment Grade;
2) EM High Yield stands to benefit more from an increased investor risk appetite in the wake of the Fed’s recent more dovish pivot;
3) EM High Yield should benefit more from potential market-friendly political outcomes in key countries. Additionally, in a more salutary backdrop for Emerging Market credit overall, we believe a neutral stance on Investment Grade is warranted.
Within Emerging Market High Yield favour Asia
Within the Emerging Market High Yield domain, we retain our preference for Asia, driven by China which accounts for almost two third of the region’s outstanding bonds. In the ongoing U.S.-China trade dispute, the two warring factions seemed to have backed off from their ill-advised policy of mutual self-destruction, at least for now. The results of this battle notwithstanding, the Chinese government’s stimulus program remains vigorous and proactive and there are early signs of improvement.
The IG rally has been sharp – we reduce to take advantage
Our upgrade of Developed Market Investment Grade bonds worked out better, and faster than expected as spreads tumbled and returns jumped.
Spreads have rallied to the extent that the potential for further gains should be viewed as limited at best. The underlying economy is softer than expected but only marginally so; and outright yields are lower thanks to the yield declines in the Treasury market
In the absence of a fundamental change in the market, we make use of the rally to tactically reduce DM IG once more.
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