What do the As and Bs in bond credit ratings mean for investors
Understand bond credit rating and broaden potential income opportunities.
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
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
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
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.
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.
Rich or cheap valuation on:
Multi-dimensional risk management is embedded at every stage of our investment process. Portfolio managers have ultimate responsibility for investment risk, with an embedded risk management function and an independent risk team providing additional layers of oversight.
Investment professionals* across sectors and markets
Asset Under Management^
J.P. Morgan Asset Management employs a diversification framework that spans the entire fixed income universe. Every stage and component of the triangle can contribute to your portfolio's risk-adjusted returns.