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Fixed Income Quarterly Outlook Q1 2016: Be selective

19-01-2016 | Outlook | Kommer van Trigt, Paul van der Worp

How to navigate fixed income markets in the New Year?  Being selective in terms of regions, sectors, maturities and seniority will grow in importance. The old fixed income adage that ‘avoiding the losers is more important than picking the winners’ will come to the forefront again. At the same time attractive investment opportunities are still out there in this diverse, global, segmented bond market. 

Speed read:
  • The challenging fixed income environment requires a flexible, benchmark unaware investment style
  • Being selective is important to identify the attractive opportunities that are still out there
  • A severe bear market scenario for bonds is improbable

The years that followed the Great Recession were excellent investment years for the more risky fixed income categories like emerging debt and high yield bonds. From a valuation perspective these categories looked attractive and this was backed by a gradual improvement in the fundamentals and technicals at the time.

In recent years the environment has changed. It started back in 2013 when the taper tantrum highlighted the vulnerability of emerging markets to a change of course in US monetary policy. Ever since, deteriorating fundamentals and technical factors have led to disappointing returns for this segment. For credits markets the turning point can be traced back to the summer of 2014 when the US high yield market started to underperform, triggered by a troubled energy sector. Since then evidence has grown that the credit cycle is maturing and caution is warranted.

Our key investment views for 2016
In the current challenging environment, we advocate a flexible, benchmark unaware investment style with a global investment universe. These are our key investment views for 2016:

  • Avoiding the losers will be just as important as in 2015 – for now we remain cautious on high yield and emerging debt. The losers of 2008 will come out again as the winners of this year – we stay positive on financials.

  • It is important to be selective within credits: we prefer EUR credits to USD credits, financials to industrials, and subordinated to senior bonds. Name-specific (idiosyncratic) risk within credits will continue to rise – a research-driven process will pay out.

  • China will continue to surprise on the negative side – we hold short-dated Australian government bonds to benefit from the slowdown scenario.

  • We live in a low growth, low inflation world economy. We therefore attach a low probability to a severe bear market scenario for bonds. Policy tightening by the Fed will be very gradual. The majority of the central banks are still in an easing mode including the European Central Bank and the Bank of Japan. As the Fed will gradually normalize monetary policy, we expect the US yield curve to flatten further. We therefore prefer long-dated US Treasuries to short-dated bonds.

  • As the divergence between the euro area and the US has peaked, we anticipate convergence in bond yields between the two blocs. We therefore prefer US Treasuries to German Bunds.
  • The ECB purchase program is supportive for peripheral markets, but their valuations look less appealing. Inter-country strategies do offer opportunities – we prefer Irish and Portuguese bonds to Italian and Spanish bonds.
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