What’s in store for bonds in 1Q 2021 as economies reopen?
1Q 2021 bond themes and potential opportunities as economies reopen.
2020 has been a remarkably eventful year for equity investors. Global stocks suffered one of the sharpest declines in the first quarter after the outbreak of COVID-19, compounded by a collapse in oil price. With central banks and governments piling on monetary and fiscal stimulus to an unprecedented degree to counter the economic impact of the COVID-19 shutdown, global stocks reversed course dramatically in the second quarter.
Supported by improving macro data, a better-than-expected earnings season and a decline in virus cases in Europe and the US, equity and credit markets rallied for much of the third quarter. But as we approach the four quarter, we see looming event risks which include the US election outcome and the brewing of a new wave of COVID-19 infections.
Against this backdrop, Australian stocks fluctuated this year. The rally in the past few months have helped recoup losses earlier this year, narrowing year-to-date total return to –10.8% as of 30 September 2020.
ASX 200 index intra-year decline vs. calendar year returns
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management. Returns are based on price only and exclude dividends. Intra-year decline refers to the largest market fall from peak to trough in a short period of time during the calendar year. Past performance is not a reliable indicator of current and future results. Guide to the Markets – Australia. Data as of 30.09.2020.
As volatility persists, allocating to fixed income can help build a resilient and diversified portfolio. US Treasuries, mortgage-backed securities (MBS) and investment grade (IG) bonds have low volatility and – more importantly – low or even negative correlation to stocks.
Different correlations to Australian equities
Source: Bloomberg Barclays, FactSet, Standard & Poors. Indices used: Australian equities: ASX 200; Treasuries: Bloomberg Barclays US Treasury Bellwethers (10Y); MBS: Bloomberg Barclays US Aggregate Securitised - MBS Index; Investment grade: Bloomberg Barclays US Aggregate Credit - Investment Grade; High yield: Bloomberg Barclays US Aggregate Credit - High Yield; Emerging Market Debt (EMD): Bloomberg Barclays Emerging Market USD Sovereign Index. All correlations based on monthly total return data in local currency for the period 29.02.2000 to 30.09.2020.
In response to the COVID-19 pandemic, central banks and governments have rolled out monetary and fiscal support unprecedented in size, timing and coordination - driving rates lower for longer. In March 2020, the Reserve Bank of Australia (RBA) cut its cash rate two times to a record low of 0.25%. It also rolled out various measures to provide cheap funding to support corporates. The RBA remains committed to supporting the economy and further easing may occur in the coming months.
Looking forward, rates are likely to stay lower for longer as the US Federal Reserve (the Fed) announced in September 2020 a shift in focus to target an average inflation level of 2% over time. After years of failing to reach its inflation mandate, the Fed is prepared to tolerate higher rates of inflation before raising interest rates to ensure an average inflation of 2%.
This pushes any expectation of a rate hike by the Fed well beyond the 2023 date priced by the market. It also means that other central banks, including the RBA, are unlikely to be able to raise their rates if the Fed doesn’t, given the impact it could cause currencies to further appreciate against the US dollar. As real rates and real yields are expected to remain negative for some time, this would further limit the appeal of core government bonds.
25% of the global bond market are negative yielding
Source: Bloomberg Barclays, BofA/Merrill Lynch, FactSet, J.P. Morgan Asset Management. For illustrative purposes only. Guide to the Markets – Australia. Data as of 30.09.2020.
Yield^^ can still be found, but may require an unconstrained approach to identify the high-conviction investing ideas. There are various types of bonds globally and they react differently to market changes such as interest rate movement and economic cycle. When managed properly, this could also mean added diversification^ in portfolios if alternative asset classes are included.
Source: Bank of America Merrill Lynch, Bloomberg Finance L.P., FactSet, ICE, J.P. Morgan Economics Research, MSCI, J.P. Morgan Asset Management.
Based on Bloomberg Barclays US Treasury (UST) Bellwether 2y & 10y (2y & 10y UST), Bloomberg Barclays Treasury Inflation-Protected Securities (TIPS), ICE BofAML Country Government (1-10y) (Australia, Germany, Japan & UK (1-10y)), Bloomberg Barclays US Aggregate, Credit – Investment Grade & High Yield (US Aggregate, IG & HY), Bloomberg Barclays US Floating Rate (US Floating Rate), Bloomberg Barclays US Aggregate Securitized – Mortgage-Backed Securities (US MBS), Bloomberg Barclays Pan-European High Yield (Europe HY), J.P. Morgan GBI-EM Global (Local EMD), J.P. Morgan EMBI Global (USD EMD), J.P. Morgan Asia Credit (JACI) (USD Asia Credit), J.P. Morgan Asia Credit (JACI) – High Yield (USD Asia HY), J.P. Morgan CEMBI (USD EM Corporate Credit), J.P. Morgan Asia Diversified (JADE) (Local Asia). *Correlations are based on 10-years of monthly returns. Guide to the Markets – Australia. Data as of 30.09.2020.
KEY LEARNINGS
Market volatility and lower yields^^ are expected to stay. It’s time to embrace the challenges, differentiate and invest where opportunities can be found via an unconstrained and flexible approach.
^Diversification does not guarantee investment return and does not eliminate the risk of loss.
^^ Yield is not guaranteed. Positive yield does not imply positive return.
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Asset Under Management^
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^ AUM figures are representative of assets managed by the Global Fixed Income, Currency & Commodities group and include AUM managed on behalf of other J.P. Morgan Asset Management investment teams.
Source: J.P. Morgan Asset Management, as of 30.06.2020.
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