The running of the bulls

Mid-Week Bond Update

The running of the bulls

Equities and the most equity-like fixed income asset classes started the year with a strong rally, buoyed by hopes of faster global growth: in the US, some investors expect the planned tax cuts will lift corporate profits and investment; in Europe, unemployment fell to a 9-year low, and in Japan, the central bank started tapering its monetary stimulus, a sign that the economy may be coming out of a two-decade...

lethargy. US five-year inflation expectations rose to 1.94%, the highest since March last year, and the US dollar rallied. Traditional risk-on sectors, such as High Yield (HY) and Emerging Markets (EM) rose, and so did oil. Long-maturity US Treasuries and European Sovereign bonds suffered, as they could be more hit in a rising rate environment and as some investors flocked to higher-yielding riskier assets.

Other developments, however, sent far less positive signals, although they were largely ignored by markets: the World Bank said global growth has mostly peaked, arguing that aging populations, low investment and productivity, and tighter monetary policies could dent both developed and emerging economies. In the US, some investors have cut their growth forecasts on the back of a bigger-than-expected November trade deficit and the December jobs report which, at an increase of 148,000, came in below expectations. Investors now await Friday’s opening of the fourth-quarter earnings season to confirm the positive momentum – or not.



Loans: looking sharp: While US leveraged loans’ 5-year average annual performance of 4.5% is outshined by the stellar returns of Equities over the same period, bank loans shine in another way: their Sharpe ratio, or how much return investors get per unit of risk, is higher than that of other asset classes, as seen on the chart. Investors seeking lower volatility tend to favour companies and sectors with high Sharpe ratios, usually associated with traditional safe-haven assets. Loans of highly indebted companies, however, are not usually considered as such – what keeps their volatility lower is the fact that they are less risky than corporate bonds, for instance, as they rank higher in a company’s capital structure. Leveraged loans also typically fare well in a rising rate environment as they usually bear floating rates, which increase as rates go up. At present, the US Federal Reserve (Fed) is forecasting as many as three rate hikes this year.


How much volatility can you stomach? Loans win the return-per-unit-of-risk race


Sharpe Ratio

Source: JP Morgan as of 9 January 2018. Av. Is average; JPM is JP Morgan; HY is High Yield; IG is Investment Grade; MBS is Mortgage-Backed Securities; Age is Agency; Agg. Is aggregate; EMBIG is Emerging Markets Bond Index Investment Grade; DJ is Dow Jones; EM is Emerging Markets; RHS is Right Hand Side. Please see disclaimers for definitions.


HY – January bump: Non-Investment Grade companies are one of 2018’s investors’ darlings, having gained 0.7% over the past five trading days. Investors keep adding to an asset class whose spreads over Treasuries have already rallied about 500 basis points over that past 2 years, reaching an 11-year low of 318 basis points earlier this week. Some investors argue the US planned tax cuts will lift corporate profits and reduce the likelihood of defaults, which already fell in 2017 to its lowest annual level since 2013. Top-performers include Retailers, after a positive Christmas season, as well as Energy, on the back of rising oil prices. Some investors, such as Brandywine Global, believe some parts of High Yield may be fully priced, although others, especially those with the highest quality, may still offer opportunity. Click here to read Brandywine Global’s blog: Are there still opportunities in High Yield?



Developed markets – curves up: US, European and Japanese sovereign rates have edged up so far this year on expectations that more central banks will follow the Fed in unwinding their monetary stimulus. Japan was the first to move, announcing a reduction in its long-term bond purchases, a move considered a minor tweak by some investors but that sent the yen 0.8% higher against a rising US dollar over the five past trading days. In Europe, falling unemployment and rising manufacturing data has increased speculation that the European Central Bank may start tapering its stimulus after the Italian general election, scheduled for March 4. And in the US, the Fed, already embarked on a monetary stimulus reduction programme, is planning further rate hikes this year. Is the so-called central bank punch bowl about to start spilling? Click here to read Legg Mason’s Annual Outlook and where some of our affiliates say investors could find value.


Yield curves steepen: Japan cuts stimulus, Europe’s unemployment falls, US hikes rates


US Hikes Rates

Source: Bloomberg as of 10 Jan. 2018. Please find definitions in the disclaimer.


Argentina – needs to beef up: The Argentinean peso was the worst-performing EM currency against the US dollar, losing 1.1% over the past five trading days. The country’s central bank cut its benchmark interest rate by 75 basis points earlier this week, from a whopping 28.75% to 28%, far less than the 125 basis point-rate cut expected by some investors. The peso has lagged other EM currencies, especially after the central bank increased this year’s inflation target to 15%, up from a previous 10%. At 23%, Argentina’s annualised inflation rate is significantly lower than in 2016, when it reached 47%. Still, some way to go.


Source for all data: Bloomberg and Barclays Capital as of 10 Jan. 2018, unless indicated.


IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.