Outlook 2018 - Global bonds: Now is not the time to chase yield

Outlook 2018 - Global bonds: Now is not the time to chase yield

The broad macro thesis marked by high debt and ageing populations remains in place and will continue to drive a low-yield environment. However, credit quality at the margin is weakening, so it’s crucial to do adequate due diligence.

What is your investment outlook for global bonds in 2018?

My broader macro thesis is unchanged: this is a slow-growth, low-inflation environment and the key structural factors bearing down on the global economy remain in place.

These factors are:

 Debt - global debt to GDP is higher than it ever has been before and that debt will require servicing, repaying and refinancing. This leaves the economy sensitive to interest rate changes.
 Demographics - the global population is ageing quickly and the share of people dropping out of the workforce as they move into retirement continues to grow. This is negative for the total number of hours worked.

Debt and demographics will continue to act as headwinds to growth and inflation. This means that bond yields are likely to stay low.

Government bonds yields should remain in their current ranges. Corporate bonds have performed very well in 2017 and that may continue in to 2018 but there are areas of this asset class that looked stretched in terms of valuations, particularly the high yield market.

Chart 1: Govt bond yields should remain in their ranges

Source: Datastream, November 2017

Chart 2: Corporate bonds have performed well in 2017

Source: Barclays Bond Indices, Datastream, November 2017

What do you think could most surprise investors next year?

Politics has the potential to throw up surprises. 2017 was a busy agenda with elections in countries including France, Germany and the UK, but none of the results really phased the market.

In 2018 there are elections in Italy. However, I think it is unlikely the Five Star Movement (M5S) - the markets’ main concern - will get into power.

In the UK, the political situation is arguably quite fragile. Although it is not my expectation, there is an outside chance of the Labour party moving in to government. If that were to happen, it would be negative for markets, and certainly for Gilts, in the short to medium term.

How do you plan to capture the best opportunities and add value for investors?

Given that we are in a very low-yield environment including for corporate bonds, now is not the time to chase yield. I would strongly advocate focussing on bond selection instead.

Credit quality is deteriorating at the margin, so it is important to conduct thorough due diligence to ensure portfolios are exposed to the right corporates with the best risk-adjusted return.

With regard to interest rate risk, given that government bond yields are at historically low levels, running duration risk at a slightly lower general level is prudent.

IAN SPREADBURY is a senior portfolio manager in fixed income. Ian joined Fidelity in 1995 and has 31 years of investment experience.

Ian holds BSc and MSc degrees in Applied Mathematics and Mathematical Statistics, respectively, and is a fellow of the Institute of Actuaries.

 

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