Why boring isn’t bad in bond markets
Harry Richards, Fund Manager, Fixed Income, examines how bond markets have reacted to increased interest rate expectations and explains why ‘boring’ isn’t bad in bond markets.
The first few weeks of 2022 have been eventful for fixed income investors. Yields on US 10-year government bonds have shot from 1.5% to 1.8% and look like they have room to rise even further. So, what is going on? Over the last year, we have transitioned from accommodative central banks and governments, who were providing a large amount of monetary and fiscal stimulus to help support the economy in the wake of the pandemic, to an environment where that support is set to be withdrawn. This is being done in the form of interest rate rises and the tapering off of central bank asset purchase programmes.
The world is experiencing a spike in the inflation data and the powerful cocktail of supportive economic policies and supply chain disruption is largely responsible, in my view. Of course, fixed income markets are forward-looking, and are currently pricing in about five interest rate rises from the Federal Reserve this year in an effort to control inflation. The belief that interest rates will be swiftly increased, combined with the expected withdrawal and subsequent reversal of quantitative easing are causing some concern. In short, the market’s ‘safety net’ is being removed and investors are starting to get nervous about the ramifications. For example, the S&P 500 Index is currently nearly 6% down year to date, while the more tech-focused Nasdaq has fallen 10% in the same timeframe.
Fundamentally, we believe that nothing has drastically changed from the pre-Covid era. The world is still heavily indebted, many economies face challenging demographic issues caused by aging populations, and the rate of technological increase means that the cost of producing goods continues to decrease. These factors will continue to act as a headwind to global economic growth and should also put material downward pressure on inflation over time. As a result, we expect bond yields to remain at relatively low levels by historical standards.
Given the current uncertainty surrounding markets and the volatility we have seen so far this year, we believe it’s not a bad time to be a little bit ‘boring’ when it comes to investments in the bond market, in order to manage risk in a year which we believe will see bouts of material volatility. For example, we currently favour high yield bonds in defensive sectors with a relatively short time until maturity with government bonds in developed markets such as the US and Australia.
Pricing power paramount as consumers’ pockets get squeezed
Jason Pidcock, Head of Strategy, Asian Income, comments on the implications of rising inflation hitting the spending power of consumers, and looks at the merits of Australia as a market for Asia Pacific equity income investors.
January saw volatility in Asia Pacific stocks, also evident elsewhere in the world, as markets pulled back from the levels seen in December, which to me looked a little expensive in some sectors. This process may not be over yet, given the change in the outlook for monetary policy in the US and elsewhere. However, we still believe many attractive growth and income opportunities can be found in the region.
A good number of these can be found in Australia. Structurally, Australia has many qualities that I find attractive for both the current and possible future economic environments. I see it as a smaller version of the US, but with a better political picture. It is home to industrious people, many of whom are 1st/2nd/3rd generation immigrants eager to get on in life, working in a free market economy with a hard currency (thanks to Australia’s diverse mineral wealth, it will be a net exporter of natural resources for decades). Importantly for equity income investors like me, it also has a corporate culture of paying attractive dividends to shareholders.
Australia is also a way that investors can play the China growth story without investing directly in China. Investors got a reminder last year of the increasingly totalitarian approach taken by the government in Beijing, as regulators cracked down on the ability of tech and private education companies to make profits. This makes me nervous from an ESG standpoint, as it raises serious questions of both governance and ethics that one doesn’t have to grapple with to anything like the same extent in many other highly appealing investment environments across the Asia Pacific region.
Looking more broadly at the macroeconomic picture, I expect inflation to remain elevated for some time and that central banks in many countries will continue to forewarn of, or continue along the path of, raising interest rates and/or pulling back quantitative easing programmes. Higher inflation means not only a squeeze on consumers’ pockets, but also on businesses. I therefore believe pricing power and sales resilience are more important qualities for a company to have than ever, in addition to a strong balance sheet.
Real economic growth rates were strong in 2021, but these were coming from an extremely low base due to the Covid-induced slump of 2020, and so I expect 2022’s growth rates to be lower than last year’s. Against this backdrop, there are three areas that stand out in my mind: companies with real assets that are able to achieve favourable re-pricing, such as some property and commodity companies; consumer staples businesses with resilient sales and pricing power, such as food and beverages; and industrial and technology companies with strong balance sheets and the proven ability to innovate and capital deployment discipline.
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A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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