Matthew Morgan, Head of Fixed Income at Jupiter Asset Management recently shared his outlook for fixed income in 2024. You can find his full outlook below and online.
Matt Morgan says after a difficult period in fixed income markets, the macro environment has changed, and it’s time for investors to get off the sidelines. He offers three ideas.
Investors could be forgiven for rolling their eyes at a fixed income investor calling the peak in yields. This time last year, the US Treasury 10-year yield had just fallen over 0.5%, having peaked at 4% in October, and credit looked more attractive than it had since 2009. Recession was sure to come in 2023.
Today, the 10-year yield has again fallen over 0.5%, having peaked at 5% in October, credit is still yielding more than it has for a decade, and recession is forecast. Three rate cuts in 2024 are priced into bond markets. I could forgive readers a little scepticism: what’s different this time?
I’d argue we are in a different place, despite the familiar pattern. Inflation is giving central banks breathing room. It would take a shock to force base rates much higher. Indeed, while the volatility in treasury markets last year was about where rates peak, the volatility this year has been about how long they stay at current levels. We’ve moved on.
History suggests that credit makes its strongest total returns from these levels, in absolute terms; and relative to equities, it’s attractive. The high yield market is above the expected 12-month equity earnings yield to an extent we usually only see in times of stress.
Clearly, the fear that’s stopping flows into the asset class is recession risk, and history is on the side of the bears: soft landings are as rare as hens’ teeth. The typical playbook of manufacturing weakness, housing pressure, consumer slowdown, job losses is still intact but taking a long time. It’s also true that growth and jobs numbers are fine for now, and fiscal spending is boosting spending to an extent rarely seen in peacetime. How long can that last?
Where we are more sanguine than some is supply dynamics. While it’s true that deficits are huge, and that some overseas demand is diminishing, there are huge pools of institutional and retail assets that are historically under-allocated to government bonds, sitting in both equities and cash. There is plenty of potential buying to bring yields down, as we’ve started to see in the last few weeks.
Using recession as an excuse to wait is understandable but a bad idea. The worst mistake a typical investor makes is not coming to the party too early, and enduring awkward conversation with your hosts; it’s arriving too late when the main course has been eaten and half the guests have moved on. Market timing is hard. Here are three ideas:
- Lock in yields now…but avoid defaults at all costs.
Much of the high yield market offers a double-digit yield today. Recession pricing is uneven. While there are companies that cannot exist if they have to refinance their debt today, there also are companies where you are being very well paid to take risk. Getting your credit research right is everything.
While the story of 2022 and 2023 in fixed income was government bonds didn’t diversify credit risk, we think that reverses in a recessionary environment, Today, you’re being paid well for a recession hedge. The combination of high yield and duration is compelling, in our view.
2) Buy emerging markets, but be smart
The yields on EM debt are attractive, but it makes sense to also mitigate the potential risk of a global slowdown. EM central banks did a much better job with inflation than their developed market counterparts. Some countries have very high real rates, with base rates way over inflation. Some countries have more space to protect their economy than others, by cutting rates.
We continue to like credit, particularly exposure to local EM growth, such as in telecommunications, utilities, banks. There is plenty of yield available in solid companies, or countries that benefit from global themes such as nearshoring. The key is to remember that EM countries are much healthier, with more local debt and a stronger domestic asset base, than they were 20 years ago.
3) Don’t forget alternatives
The story of the last two years was, nowhere to hide when credit struggles because rates rose too. Investors scrambled to reallocate to absolute return funds, having forgotten they needed them in the long bull market in bonds. Investors are now, rightly in my view, turning back to duration as a diversifier, but I would caution against making the same mistake again; for structural reasons, volatility in rates is likely to remain high. A proper, bona fide absolute return fund – beware those that rely on credit for returns – is something that I believe should be part of a well-diversified fixed income portfolio.
