Over the past months bond market participants had questioned at which point of the cycle fixed-income markets were. Many argued that we were at peak levels and an imminent sell-off would be probable following three strong years of gains. To date in 2016, the bond market emerged as one of the best-performing asset classes with hard currency bonds (in this case
To date in 2016, the bond market emerged as one of the best-performing asset classes with hard currency bonds (in this case dollar-denominated bonds) recording double-digit gains on a year-to-date basis.
As I have opined in my previous writings, the main contributor towards the strong performance of the said asset class is the continuous monetary stimulus by major Central Banks. The theoretical perspective of lower interest rates has pushed yields lower, thus pushing prices higher, while the announcement by the European Central Bank last March which mainly indicated an expansion to its quantitative easing program to corporate bond buying, also emerged as another reason for a decline in yields across all levels of the said asset class.
In the month of August, once again the bond market emerged as a resilient asset class with further tightening across the board. The expectation of further stimulus in Europe was one of the prime factors with yields moving notably lower. There is now USD13.5 trillion of global negative-yielding debt, according to Bank of America Merrill Lynch. That compares to USD11 trillion before the Brexit vote, and barely none with a negative yield in mid-2014.
According to the BOFA index, European High yield in August registered a gain of 1.42 per cent in price return terms, while on a total return basis the gain was that of 1.85 per cent. Intuitively, bond investors are hoping for further quantative easing, however my view is that on a risk-adjusted basis investors are now not being compensated at the current valuations within the said asset class. Total return year-to-date stands at 7.8 per cent.
As investors fled in search for yield, due to the record lows within the Euro area, US high yield gained a total return of 2.23 per cent, also pushed by the strong gains of circa 10 per cent in oil prices, of which a substantial amount of the US high yield market is composed of energy companies. A year-to-date total return of 14.6 per cent is quite a feat when considering that only six-months ago US high yield was 5 per cent lower in the first weeks of the year.
In line with the US high yield market, emerging market bonds gained in total circa 1.73 per cent, this time round a less strong momentum in terms of gains, as some investors are possibly factoring in a possible rate hike and its impact on the companies’ ability to service and re-financing their dollar-denominated bonds.
My view is that we should expect slightly further tightening in yields, however cautiousness going forward should be the order of the day. In times of volatility, at the current valuations levels, the downside risk is notably much higher than the now possible upside momentum. So let’s continue the hunt for yield but ensure that we are being compensated accordingly for the risk being taken.
This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.