4Q 2021 bonds: themes and opportunities as rates look set to rise
Looking at bond themes and opportunities in the final quarter of 2021.
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Key takeaways:
- Global economic growth has rebounded and the recovery could extend into 2021 amid supportive policy measures and containment of the public health emergency. Still, how the crisis continues to unfold could determine economic and market performance going forward.
- Asia has emerged as an investment spotlight with China becoming a relatively attractive opportunity.
- Flexibility is key when investing in bonds. And in the current market environment, Asian bonds and investment-grade bonds are gaining traction. A diversified portfolio could be considered to help manage risk while seeking growth.
Economic activities have gradually resumed after the fallout of the global public health crisis. Still, the pace of the recovery could falter as governments try to strike a balance between maintaining economic momentum and mitigating risk from new waves of infections. How are investors charting the path forward as a ’new normal’ emerges?
Recently, we hosted a virtual conference where our investment experts discussed four key themes in a ‘new normal’, and the outlook for various asset classes for the coming year.
The global economy rebounded in 3Q 2020, primarily driven by supportive fiscal and monetary policies and tougher health crisis control measures in the second half of the year. With the public health threat still looming, we believe the world’s economy could advance at a modest rate in 2021. The pace of recovery could accelerate if an effective vaccine is developed, or if sustained medical solutions become available.
At the same time, major shifts in central banks’ asset purchases are unlikely. Governments could take a longer-term view when implementing fiscal measures. These could be smaller in scale than in previous years, but with clearer objectives and priorities given to sectors that require more support.
For equities, advances in vaccine research and development have led to a rotation in various sectors. With the health crisis easing in some locations, investors may be attracted to sectors that are relatively undervalued and where earnings growth could be optimal. As uncertainty over the public health threat persists, equities investors could be flexible in allocation and consider the growth priorities of the broader economy.
For bonds, the zero or ultra-low interest rate environment continues to pose challenges for traditional fixed income, and requires selective allocation. In the current environment, high-yield bonds and emerging-market debt are relatively attractive investment avenues while yields, prices and exchange rates appear positive for Asian bonds.
How the public health crisis could play out in 2021
Scenario |
Breakthroughs in vaccine development, or rapid testing is more commonly available |
The public health threat persists into 2H 2021, or even end-2021 |
Growth |
Economic growth accelerates, especially for personal consumption |
Economic recovery slows |
Policy |
Governments may moderately tighten fiscal measures to reduce deficits, but monetary policy could remain accommodative |
Fiscal deficits remain high and central banks may introduce more policies to support businesses |
Sectors that could potentially benefit |
Energy and raw materials, travel and entertainment, industry and finance |
Technology, healthcare and defensive equities could remain the leading sectors |
Forecasts, projections and other forward looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecast, projections or other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.
Despite tumultuous markets this year, Asian equities have largely been positive mainly because the region’s control measures helped slow the spread of infections, allowing for quicker recovery of economic activities and corporate earnings. When growth is lacking, investors generally favour growth investments. Low interest rates have enabled growth companies to advantageously borrow at lower costs, while well-managed, high-quality companies are also better-placed to tackle adversity. Investors could focus on identifying "growth" and "quality" equities for upside potential.
For Asia, growth could be driven by three key themes: lifestyle upgrades, changing demographics and the expansion and deepening of financial services. Affluent consumers are seeking a better quality of life and this could accelerate consumer demand. In addition, an aging population could drive demand higher for healthcare while a declining birthrate could prompt parents to spend more on children’s education. Rising wealth has also led to an increase in demand for financial products such as insurance, credit cards, mortgages, and asset and wealth management services.
[Read more: "Finding growth: there’s still more to know about Asia"]
Looking ahead to 2025, China could become the world's largest economy, while India and Indonesia are also expected to be among the top 10 economies.1 The MSCI AC Asia ex-Japan Index has evolved over the past 20 years, where the weighting of financial sector has dropped, while that for technology stocks has steadily increased. Non-staple consumer and healthcare have also risen significantly, reflecting a more diversified index that mirrors structural growth. Over the past decade, there were also numerous listings of online shopping, gaming, entertainment platform, financial technology and medical services companies from China, and more unicorns are expected to debut in the future. Asian stock markets have become relatively diversified, with South Korea and other Southeast Asian economies offering potentially attractive opportunities. When selecting equities, investors could consider a company's long-term operating environment and competitiveness.
Bond prices have been volatile this year. With a new round of economic expansion, we currently prefer a flexible bond allocation approach. In an easing environment, inflationary pressures have been unfavourable for bonds, making it tougher for government bond investors to generate their targeted returns. Therefore, it could be beneficial to seek other sources of high-quality income across the full spectrum of fixed income.
In Asia, China is the region’s leading economy. Increased issuances of Asian US-dollar (USD) bonds could be positive for the corporate bond market. Different types of Chinese bonds currently offer opportunities for relatively attractive yields, with renminbi (RMB)-denominated Chinese government bonds at 2% to 3%, USD investment-grade bonds at around 5% to 6%, and some Asian local-currency government bonds at over 6%2. In addition, US bond prices have risen amid monetary easing, making Asian USD credit relatively attractive compared with their US counterpart.
With interest rates likely to stay ultra-low in 2021, investors, in their search for higher yield, could also keep an eye on the stability of bond issuers and consider the risk factors of different bond classes to help maintain a low correlation in asset allocation. Under the current market environment, we believe that investing in government bonds could present higher interest rate risk. In the search for quality corporate bonds, investors, based on their investment objectives and risk appetite, may also look for fixed income assets with a low correlation to government bonds, such as high-yield corporate bonds, asset-backed securities and mortgage-backed securities. They could also consider a flexible bond strategy to better manage duration under different market conditions, and to help mitigate interest rate risk. At the same time, investors could also look for opportunities in foreign exchange, such as RMB and other local currency bonds in Asian markets, to help capture the potential for currency appreciation.
The global economy has entered a new cycle. After a slowdown earlier this year, there has been a significant recovery in growth. In this new cycle and new market environment, investors should be mindful of the new challenges:
- Accommodative monetary policy has provided support to the economy, but a growing number of negative-yielding government bonds in mature markets and relatively high equity prices may not provide significant upside potential. In a low interest rate environment, the search for yield has become tougher.
- The direction and magnitude of future economic growth will largely depend on how the pandemic could play out. It is still unknown when a vaccine could be launched and become widely available, or whether there could be an exponential rise in infections, adding to volatility in the markets.
Under such circumstances, traditional asset classes may not provide attractive returns and portfolios could become more diversified to include non-traditional assets. The level of return generally varies by asset class. Some hybrid assets, such as preferred stocks, currently appear to be attractive with the majority being bank stocks. Preferred shares are generally higher in the capital structure compared with ordinary equities. Current interest rates reflect asset improvements in the global banking sector since the previous financial crisis. The higher cash reserves of US and European banks, as a result of policy restrictions on dividend payouts and share buybacks, also provide support for preferred stocks.
Among global real estate investment trusts, a number of publicly owned or manufacturing real estate projects are scheduled to be completed as the global economy recovers. Other categories include mini-warehouses, data centres for cloud computing and logistics centres for online shopping platforms.
Conclusion
As the global economy enters a new cycle and a ‘new normal’, investors could consider employing flexible investment strategies. And moving into 2021, staying on top of the four investment themes could help them optimise the potential growth opportunities.
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Provided for information only based on market conditions as of date of publication, not to be construed as investment recommendation or advice.
Diversification does not guarantee investment return and does not eliminate the risk of loss. Forecasts, projections and other forward looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecast, projections or other forward statements, actual events, results or performance may differ materially from those reflected or contemplated. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstances and market conditions.
1. Source: World Economic Outlook (October 2020), J.P. Morgan Asset Management. Data reflect most recently available as of 22.10.2020. Provided to illustrate generic market trends only, not to be construed as research or investment advice.
2. Source: Bloomberg, J.P. Morgan Asset Management, as of 15.09.2020. Data used: 5-year CNH Chinese Government Bonds Index (Renminbi Chinese government bonds), JPMorgan Asia Credit Index – Investment Grade (CNH hedged) (USD investment grade bonds), 10-year local currency government bond (unhedged) (Asia local currency government bonds). Yield is not guaranteed. Positive yield does not imply positive return. Indices do not include fees or operating expenses and are not available for actual investment.
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