Flexible fixed income: Three ideas for 2019 - J.P. Morgan Asset Management
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Flexible fixed income: Three ideas for 2019

Contributor Iain Stealey

In what is undoubtedly a challenging environment for fixed income, what opportunities are available to investors who are able to loosen the constraints of their bond portfolios? Iain Stealey, International Chief Investment Officer of Global Fixed Income and Portfolio Manager for the JPMorgan Global Bond Opportunities Fund and JPMorgan Global Bond Opportunities ETF, discusses three of his team’s best ideas, and one to watch as markets shift through the year.

1. Capitalizing on consumption: Short-duration securitized U.S. credit

As a play on the strength of the U.S. consumer, we like securitized credit, where the credit risk lies in the ability of consumers to repay loans on their household purchases. Consumer confidence, although down from its October 2018 peak, remains elevated vs. the 10-year average.1

The sector offers an attractive combination of yield advantage (3% at the index level) and limited duration (2 years at the index level),2 and provides diversification to corporate credit allocations, as well as to mortgage-backed securitized products.

Product pick: Securitized car loans – compelling fundamentals given that 85% of U.S. workers require a car to get to work.3

CONSUMER CONFIDENCE REMAINS HIGH

Conference Board Consumer Confidence Index


Source: Conference Board, Bloomberg; data as of 1/31/19.

2. Spread story: U.S. high yield

Despite the strong performance of risk assets since the start of the year, spreads of over 430 basis points for U.S. high yield look attractive given the strong fundamentals evident in default rates, which we expect to remain between 1% and 2% until economic activity weakens.4 Rising stars (companies being upgraded to investment grade) are outpacing fallen angels (companies being downgraded from investment grade)—another sign of fundamental strength.

Technical factors are also supportive, with issuance muted and demand having resumed strongly in 2019.

Sector pick: Healthcare – positive fundamental trends, driven by an aging population. The regulatory environment has stabilized, and servicing is transitioning from acute care in hospitals to lower-cost settings, which is positive for corporate cost bases.

DEFAULT RATES ARE LOW

U.S. high yield default rates


Source: Moody’s, J.P. Morgan Asset Management; trailing 12-month par-weighted default rates; data as of 1/31/19.

3. Local hero: Local currency emerging markets debt

2018 was a story of economic divergence, with the U.S. enjoying above-trend growth even as recoveries faded elsewhere. With tighter U.S. monetary policy came a stronger dollar, driving significant underperformance for emerging markets debt.

We think the extent of the sell-off was overdone, and yields now look attractive relative to fundamentals in selected markets. In addition, the recent shift in tone from the Federal Reserve (Fed) means it’s likely that there will be an earlier-than-anticipated pause in the U.S. hiking cycle, which would be positive for emerging markets.

Country pick: Indonesia. The country has seen good growth and strong inflation, resulting in a central bank hiking cycle that is now at or near its peak. We expect more accommodative monetary policy in the future—a positive for the bond market. Fiscal policy has also been well managed by the government.

INFLATION-ADJUSTED YIELDS ARE WELL ABOVE THE HISTORICAL AVERAGE

Emerging market local real yields (ex-Turkey)


Source: Bloomberg, J.P. Morgan Asset Management; data as of 2/1/19. Chart depicts yield to maturity for JPMorgan GBI-EM Global Diversified Index.

One to watch: Duration

Although U.S. momentum shows signs of fading and Fed language has changed, economic fundamentals remain robust, and our base case is still for one or two rate hikes this year. We think the market is mispricing the likelihood of further hikes (current implied expectations are for zero hikes in 2019),5 so we remain short at the front end of the yield curve.

However, we have become more positive on duration overall—expressed through long positions further out on the curve—as we recognize we’re nearing the end of the cycle, meaningful risks loom around trade, and further fiscal stimulus in the U.S. is very unlikely given the divided Congress.

How we’re playing it: Tactical vs. strategic

Strategically, we recognize that we are nearing the end of the cycle and are adding ballast to the portfolio. Tactically, though, we are looking for opportunities to add risk given the more dovish central bank backdrop, which has the potential to prolong the economic cycle.

Loosen the constraints of your bond portfolio

Take a selective approach to the opportunities in bond markets around the world with the JPMorgan Global Bond Opportunities Fund. The fund targets attractive risk-adjusted returns in different market and interest rate environments by providing flexible, high-conviction exposure across 15 fixed income sectors and over 50 countries.

Learn more about JPMorgan Global Bond Opportunities Fund (GBOSX)

Learn more about JPMorgan Global Bond Opportunities ETF (JPGB)

Learn how these Funds fit into your bond portfolio here


1 Source: Bloomberg; data as of 1/31/19.
2 Source: Bloomberg Barclays; data as of 1/31/19.
3 Source: US Census Bureau, 2017 data (most recent). Includes 116,736,603 solo commuters and 13,604,253 who carpool.
4 Source: For spreads: Bank of America Merrill Lynch, Bloomberg; data as of 1/31/19. For default rates: Moody’s, J.P. Morgan Asset Management; data as of 1/31/19.
5 Source: Bloomberg; data as of 1/31/19.


RISK SUMMARY

Investments in bonds and other debt securities will change in value based on changes in interest rates. If rates rise, the value of these investments generally drops.

International investing bears greater risk due to social, economic, regulatory and political instability in countries in "emerging markets." This makes emerging market securities more volatile and less liquid developed market securities. Changes in exchange rates and differences in accounting and taxation policies outside the U.S. can also affect returns.

Securities rated below investment grade are considered "high-yield," "non-investment grade," "below investment-grade," or "junk bonds." They generally are rated in the fifth or lower rating categories of Standard & Poor's and Moody's Investors Service. Although they can provide higher yields than higher rated securities, they can carry greater risk.

The value of investments in mortgage-related and asset-backed securities will be influenced by the factors affecting the housing market and the assets underlying such securities. The securities may decline in value, face valuation difficulties, become more volatile and/or become illiquid. They are also subject to prepayment risk, which occurs when mortgage holders refinance or otherwise repay their loans sooner than expected, creating an early return of principal to holders of the loans.

The Fund is actively managed and there is no guarantee the Fund will achieve its investment objective. Actively managed funds typically charge more than index-linked products. Diversification may not protect against market loss.

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