Bond investors need to think in a portfolio context and should not get in and out of bonds in trying to pick the bottoms from the tops, said Jeff Rosenberg, chief investment strategist for fixed income at BlackRock.
The value of US Treasury securities act as a ballast and offsets the risky instruments in a portfolio that investors add for income and capital appreciation. When things go wrong, Treasury securities have demonstrated they can act as ballasts in portfolios, he noted.
While high-grade corporate and government bonds have rallied in recent months, high-yield/junk bonds failed to participate though they have shown signs of improvement. Asked if junk bonds still offer value or if the lack of investor interest is some kind of a signal that risk-aversion is still out there, Jeff said it’s a little bit of both.
The markets got ahead of themselves with regards to the immediacy of risks that was witnessed in January & February including low oil prices and collapsing commodities, and high-yield is a reflection of that. Investors are now seeing a much riskier environment; so when they enter into those asset classes, they really need to be cautious because the backdrop for defaults is really behind the markets and the markets are going into a higher default environment.
That means extra caution when taking up higher risk investments in fixed-income securities such as high-yield. That being said, certainly investors have seen a tremendous rally and recovery in global credit markets, partly because oil prices stabilized, and partly because of the expansion of corporate bond purchases by the European Central Bank, he explained.
While a lot of things have changed in the equity and bond markets in the past one month, the main driver has been weakening of the USD against emerging-market currencies and the euro. Asked how much a weaker dollar was responsible for the rebound in oil and stocks and if the rally would continue, Jeff said a weak dollar was one of the critical factors.
The Federal Reserve is trying to normalize interest rates in an environment where the rest of the world is highly accommodative – the impact of which was the dramatic strengthening of the dollar. When investors denominate their debts in dollar but not their cash flows, their indebtedness goes up when the value of the dollar goes up, which puts pressure on the markets.
Fed chief Janet Yellen’s pushing back a bit was very helpful, which weakened the dollar and helped stabilize commodities. There’s a window of opportunity with the Fed pulling back and a little bit of dollar weakness. However, investors should not get ahead of the market because a lot of the underlying imbalances such as the excess capacity in the commodities sector and the vulnerabilities there have the potential to bring back the stories around oil prices, he observed.
US corporates can now head to Europe and raise capital at almost zero percent amid a negative interest rate environment. There were speculations last month that a lot of money flowed into emerging markets – partly because of the dollar’s strength and partly because of Janet Yellen’s guarantees.
Asked if emerging-market valuations would become even more attractive, Jeff said emerging markets are already very attractive because valuations have changed dramatically. The price of admission for a US-based dollar investor to get into emerging markets is generally the currency.
Investors can’t get really bullish on fixed-income in emerging markets until there’s more stability on the dollar. The Fed pulling-back on normalization in the near-term has given investors a small-window of opportunity, but investors shouldn’t get too excited given that there are still some vulnerability with regards to commodities and commodity exposures down the line, he concluded.
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