So far this year it looks like my wish has come true. The Father Christmas of bond markets seems to have heard my plea and yields have risen across the market.
The yield on 10-year US treasuries has jumped from less than 2.5% to a recent peak of 2.95%, just shy of the psychologically important level of 3%. While the move in yields has been most drastic in government bond markets, corporate bond spreads have also widened on the renewed volatility.
Why I like current markets
As a high-conviction stock picker, volatility is my ticket to finding attractive entry points to the companies that I like. Lately, credit spreads have moved ever tighter with little regard for fundamentals. A sell-off reminds investors of an important lesson: fundamentals matter. As dispersion between the performance of issuers returns to the market, those who focus on in-depth, bottom-up analysis will be rewarded as the market remembers it should be more discerning with its allocation of capital.
Anyone can make money in a rising market. What differentiates active managers is their ability to generate alpha for clients in turbulent markets. We don’t expect a sustained bond market sell-off, but during any period of volatility, investing in the right places and taking advantage of market moves is essential in adding value for clients.
Remember, the bond market is not a single entity, some areas of the market will deliver solid returns when other areas do not. Retaining a flexible and global approach ensures active managers can take the opportunities across the fixed income universe when volatility strikes.
Not all parts move together
It seems likely that yields in government bonds will gradually rise as monetary authorities loosen the reins and the global economy improves. But yields won’t rise in a straight line. Central banks will be cautious as they address the process of ‘normalisation’, given inflation is yet to find a firm footing.
Indeed, individual economies will perform differently, yields will rise and fall at different times across the globe, so a global approach is logical when searching for relative value opportunities. We also expect rates markets will experience periods of consolidation and will indeed perform well at times. That’s why we take a dual-pronged tactical and strategic approach to interest rate risk, taking advantage of the global market – regardless of its overall direction.
Corporate bonds will likely perform well in this, still supportive, macroeconomic environment as improving global growth feeds into already strong business fundamentals. As such, we do not expect a significant blow-out in spreads, nor do we see an obvious catalyst for such a move. But we no longer expect spreads to grind ever tighter with little regard for business fundamentals; stock selection will increasingly be essential in generating attractive risk-adjusted returns.
I’m hoping for continued volatility
In my Christmas wish I noted that Germany was struggling to form a coalition government, that Italy could remind us of the power of populism and that US tax reforms aren’t a given. Since then, Germany has managed to form a coalition, but the Italian elections resulted in a clear defeat for centrist parties and populism was indeed resurgent.
While the US tax reforms did go through, and the corresponding fiscal boost should help the global economy, President Trump has potentially ignited a trade war with his proposed tariffs on aluminium and steel, prompting the resignation of his chief economic adviser in the process.
It is undoubtedly an interesting and exciting time to be a bond manager. As long as volatility prevails, active managers and our clients can benefit from it.
