January 2020 / INVESTMENT INSIGHTS
Quarterly Outlook: Reflation Theme Gains Momentum
- Our base case is that the trends of major central banks staying on hold and global growth improving will continue in early 2020.
- Geopolitical risk needs to be factored back in. While trade tensions between the U.S. and China appear to have receded, geopolitical risk in the Middle East and Asia has picked up recently.
- Overall, we believe the current environment calls for a tactical approach, which should provide a tailwind for our strategy, as we have the flexibility to adapt quickly to changes in market conditions.
The reflation theme gained momentum during the fourth quarter of 2019 as the global macroeconomic environment showed signs of recovery. This led investors to add risk back into their portfolios, which resulted in gains for risk assets, such as equity and corporate bonds. At the same time, developed government bonds struggled as the stabilization in growth reduced the prospect of major central banks delivering further interest rate cuts.
Base Case for 2020
Our base case is that the trends of major central banks staying on hold and global growth improving will continue in early 2020. To reflect these views, we express short duration stances in high-quality countries. We have also built up our long positioning in currencies and local bond markets of select emerging market countries that we feel could benefit from a stronger global growth environment.
Dispersion of Returns in the Credit Sphere
In the credit sphere, we are seeing signs of instability in some pockets of the market. For example, in U.S. high yield, the overall positive performance during the final quarter of the year masked the dispersion of returns, with spreads on the riskier CCC-rated segment of the market significantly lagging performance of higher-rated bonds in the BB and B categories. It’s possible this trend will continue in 2020 with investors more mindful of where they place risk this late in the economic cycle.
Liquidity can also be issue for the more distressed parts of the high yield market. Against this backdrop, we marginally added back to credit hedges in December. At the same time, we took profit on some of corporate bond exposures, which brought our overall credit stance in the portfolio back to around neutral.
Caution amid Heightened Geopolitical Risk
Geopolitical risk needs to be factored back in. While trade tensions between the U.S. and China appear to have receded, geopolitical risk in the Middle East and Asia has picked up recently. Further escalation could easily dent investor sentiment and halt the rally in risk assets. Against this backdrop, we believe it’s important to stay cautious, particularly as the economic recovery remains in the early stages.
Adapting to Changes in Market Conditions
Monitoring economic data will be important going forward as we look for signs of further improvement in the global economy. Overall, we believe the current environment calls for a tactical approach, which should provide a tailwind for our strategy, as we have the flexibility to adapt quickly to changes in market conditions. We will continue to follow our trusted investment process and strive to maintain a portfolio that strikes a balance between country, duration, and yield curve positioning to take advantage of relative value opportunities globally while also managing downside risks.
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