Compelling valuations and a more pro-growth stance from central banks facilitated a robust rebound in corporate credit in the first quarter of 2019. To sustain this rally, global economic momentum may need to improve and translate into more earnings upgrades.
We are cautiously optimistic as economic policies are adjusted to keep this economic hang glider in the air for as long as possible.
Monetary authorities, especially in the US and China, have adopted more accommodative stances this year. The US Federal Reserve’s decision to pause rate hike and to put an earlier end to its balance sheet run-off may lower the risk of a US recession in the near term, and help to extend the decade-long economic expansion.
A chart to monitor through the second quarter of 2019
This late-cycle environment presents potential opportunities in income-generating assets, including a number of fixed income sectors that have relatively stronger correlation to equities as shown in the top right corner of the chart below.
Yields and correlations of fixed income returns to equities1
- Global high-yield bonds2 are expected to benefit from the Fed’s pause on rate hike because it is more difficult for US Treasury bond yields to rise significantly, unless inflation surges. A lower possibility of a near-term US recession would also mean a lower threat of rising defaults. US high-yield bonds’ fundamentals remain resilient. Low issuance also provides technical support.
- Emerging market bonds are seeing some reprieve from the Fed pause and lower Treasury yields. Investor sentiment has improved with a US-China trade deal in the works.
Meanwhile, quality US securitised credit, in particular, consumer asset-backed securities, also presents opportunities in the late cycle. US households are in a relatively good shape in fundamental terms as they have de-leveraged significantly after the global financial crisis. The household debt service ratio remains low with 9.9% in the first quarter of 2019, versus 13.2% in the fourth quarter of 2007). And household net worth has increased substantially in recent years (US$109 trillion in the first quarter of 2019, versus US$69 trillion in the third quarter of 2007) 3.
1 Source: Bank of America Merrill Lynch, Bloomberg Finance L.P., FactSet, ICE, J.P. Morgan Economics Research, MSCI, J.P. Morgan Asset Management.
Indices represented are: 2y & 10y UST: Bloomberg Barclays US Treasury (UST) Bellwether 2y & 10y; TIPS: Bloomberg Barclays Treasury Inflation Protected Securities (TIPS); France, Germany, Japan & UK (1-10y): ICE BofAML Government (1-10y) for each country; US Aggregate: Bloomberg Barclays US Aggregate Bond; US IG: Bloomberg Barclays US Aggregate Credit – Investment Grade Corporate; US HY: Bloomberg Barclays US Aggregate Credit – High Yield Corporate; US Floating Rate: Bloomberg Barclays US Floating Rate; US MBS: Bloomberg Barclays US Aggregate Securitised – Mortgage-Backed Securities (MBS); Europe HY: Bloomberg Barclays Pan-European High Yield; Local EMD: J.P. Morgan Government Bond Index – Emerging Markets Broad; USD EMD: J.P. Morgan Emerging Market Bond Index Global; USD Asia Credit: J.P. Morgan Asia Credit (JACI); USD Asia HY: J.P. Morgan Asia Credit (JACI) – High Yield; USD EM Corporate Credit: J.P. Morgan Corporate Emerging Markets Bond.
*Correlations are based on 10-years of monthly returns. Yields shown are 12-month average yields-to-maturity. Data reflect most recently available as of 31.03.2019.
2 Yield is not guaranteed. Positive yield does not imply positive return.
3 Source: FactSet, Federal Reserve Board, Bureau of Economic Analysis, J.P. Morgan Asset Management. The first quarter 2019 figures for debt service ratio and household net worth are J.P. Morgan Asset Management estimates. For illustrative purposes only. Past performance is not a reliable indicator of current and future results. Data reflect most recently available as of 31.03.2019.
Investment involves risk. Investors should consult professional advice before investing. The opinions and views expressed here are those held by the author as of the date of this publication, which are subject to change and are not to be taken as or construed as investment advice.