1. U.S. CCC Rated Corporate Debt Returns 15%
Low rated debt already had a good run into the year-end close, but CCC rated debt still trades at a yield of 12.3% and a yield spread to U.S. Treasuries of 998 basis points (bps). Much of what is in the CCC rated space are energy names that may have to go through further restructuring. But the Phase 1 trade deal between China and the U.S. suggests that energy exports to China will pick up to cover some of the USD 200 billion in required additional purchases. Further, the OPEC+ countries are showing some resolve on maintaining production cuts. Throw in a bit more global growth and oil could stabilize at slightly higher levels, providing a tailwind to the CCC space. The math is also pretty compelling: If CCC yields fall 250 bps to 9.8% (the low in 2018), that adds 7.5% in return to the 12.3% yield. Assuming default rates of 10% (the last 12 months saw 11% default rates) and a 48% recovery nets a 15% return for the year. Any greater decline in overall yields or reduction in default rates means that 20% is not unrealistic either!
2. Local Emerging Market Debt (GBI) Returns 15%
With a trade war, a global growth slowdown and constant pockets of geopolitical stress, this was not supposed to be a good year for emerging market debt (EMD). Yet local EMD returned about 13.5% headed into year-end. Imagine the returns that could be had if there is a genuine trade compromise and emerging market currencies begin to reflect a recovery in global manufacturing. Although the overall yield on the index is at 5.2%, some of the high yielders, where real yields are too high, have room to fall in yield, which could add price appreciation. But the big gains to be made should come in the currency markets. To get that 10% appreciation relative to the USD, it’s probably less about EMD flows and more about equity investors returning in earnest to the emerging markets. That will propel the currencies nicely.
3. Gold Returns 10+%
Gold appreciated 18% in 2019, but it’s hard to find any bear case headed into 2020. It is the ultimate tail risk hedge. If there is a strong global economic surge emanating from a trade war compromise, gold will surely benefit as an inflation hedge as investors begin to fear that the amount of central bank stimulus in the system could be ignited. If the trade wars re-escalate and the central banks do nothing further, then it will benefit from a flight-to-quality bid. If there is no tail risk present and the global economy continues to muddle along, it feels like gold still has some upside momentum. It is likely that the dollar will continue to fade from a strong 2019, and gold does act as the ‘anti-dollar’. Further, if central banks and yields stay where they are, more insurance companies are likely to add to their holdings rather than pile further into negative yielding debt.
4. The Yield on the 10-Year U.S. Treasury Falls to Under 1%
The growing narrative is that a bottom in the global economy and yields has been put in and the next phase in the cycle is a reacceleration. For those expecting a global growth and inflation resurgence, this will not be a popular pick. But trade tensions still exist and there doesn’t seem to be a credible solution to the hard issues, such as intellectual property (IP) and technology transfer rights. Is this simply a pause before the trade tensions re-escalate by the middle of 2020? Don’t forget there is also Brexit for both the UK and EU to deal with. Again, perhaps an unsolvable riddle. Finally, we are headed into a U.S. general election whereby the rhetoric from Democrats and Republicans will crescendo. Do we hear a chorus of higher taxes and more regulation from the Democrats while the administration plays to its core by talking about widening the net on tariffs to include Europe and Latam? All of these potential issues will be difficult for the markets and economy to digest, and could mean the central banks have little choice but to cut rates and expand balance sheets further.
5. President Bloomberg
While he faces skepticism and low single-digit polling numbers, let’s remember that in topsy-turvy 1976, Jimmy Carter had worse polling numbers, less name recognition and much less money in December 1975 than Bloomberg today. We need to consider what a Bloomberg presidency would mean for markets. He advocates for a higher minimum wage, a somewhat more progressive tax system and the end of carried interest. Centrist positions may allow him to get both sides of the aisle to agree on an infrastructure spend and structural reform. As Bloomberg’s fortunes rise, markets will price a risk-on bias ... and much higher bond yields.
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 forecasts, projections and other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.
J.P. Morgan Asset Management does not predict outcomes of any political events, nor do we voice firm-wide opinions on any political candidates.