Bond investors chasing yield should look further afield to shake off the blues
- The ultra-low interest rates adopted to fight off global economic malaise have made government paper in developed markets less attractive
- Corporate credit and emerging market debt will have to be part of the playbook, and investors must do their homework to identify the companies and sectors that would do well in a pandemic
Bond investors are feeling blue these days. Bonds are supposed to provide a stable income and offset the volatility of buying stocks. But the crushing of global interest rates to zero has sapped bond yields, eroding their appeal. Put another way, fixed-income assets are providing little to no income.
Unfortunately, it seems pretty unlikely that the income payout on bonds is going to rise any time soon. Governments around the world are determined to nurse economies recovering from Covid-19 back to health. To do this, they’re deploying mass support like making the cost of money cheap. That’s helping the flow of credit in the economy, but it’s a disaster for savers who want income from safe investments.
Yet there is some hope, even in a yield-constrained world. The lagging recovery in service industries like travel and hospitality, in many parts of the world, will dampen any economic rebound.
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Central banks may appear spent after a busy period propping up governments’ ability to spend, but they continue to show a willingness to do more to plug economic holes. Recently, central banks in New Zealand and England have tilted towards using negative rates, while further rate cuts and outright quantitative easing (central banks buying up the supply of bonds) is expected in Australia.
All these fairly extraordinary interventions ensure that borrowing costs are kept low, which is great for spenders, but less so for those trying to squeeze income out of investments.
The good news is that there are still some pockets of income available for those who look. Areas like corporate credit and emerging market debt that tend to do well in the early parts of an economic recovery cycle, where we are at now, will have to be part of the playbook.
Income hunters who are finding that government support for higher-quality corporate bonds has stunted their yields are also turning to lower-quality but higher-yielding corporate bonds. However, the additional payouts these high-yield bonds offer come with risks.
Identifying those sectors and companies that will continue to bridge the coronavirus-induced economic void entails combing through promising sectors such as technology, health care, telecoms and banks, and being aware of the risks around retail, energy and leisure-related services.
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Meanwhile, emerging market debt is immediately more appealing than developed market bonds as real yields – yield adjusted for inflation – are positive. But there are some dangers here, too.
The first is how well the country has managed the Covid-19 pandemic and whether further large-scale fiscal spending may be needed to support the economy. Better management suggests a more stable financial position.
Related to this is the central banks’ role. Emerging market central banks have dabbled in bond-buying programmes to stabilise markets and support government spending. Such policies can be positive in creating demand for bonds but the durability and success of these policies need to be assessed.
Finally, if market expectations are right about the US elections and a Democratic clean sweep leads to another splurge in government stimulus, this may actually benefit some emerging markets via a depreciating US dollar.
The stimulus could present a double-edged sword: it would help investor sentiment and support extended parts of the bond market, but pumping trillions of dollars into an economy on the mend could lead to surging inflation, the enemy of bond investors, and rising policy rates. However, the level of spare capacity in the US and most other economies implies that the risk of inflation is not an immediate concern.
Bonds used to be a sort of ballast for portfolios that enabled greater risk-taking in areas like stocks. Government bonds will always have a role even when income is virtual non-existent. But when yields are as low as they are today, any hope for income relies on looking across a broader set of options, even if it means proceeding with caution.
Kerry Craig is a global market strategist at JP Morgan Asset Management