Sequel or prequel
The return of supportive monetary policies dominated fixed income markets during last six months ending September 30th 2019. So, with a sudden dovish shift initiated at its March meeting, the US Federal Reserve has been driving risk appetite in the global markets once again. In July, the Fed cut its main interest rate for the first time in a decade (followed by a second cut in September) and this prompted other central banks to follow suit with the European Central Bank notably restarting its bond repurchase programme and announcing new monetary support measures. These U-turn changes in policy resulted in an unconventional phenomenon of equities and bonds rallying alongside each other, with the rally in credit markets becoming more technical than fundamental.
Interest rates are now forecast to stay low for an extended period and global markets have been pricing in four interest rate cuts by the Fed over the next 12 months. Searching for yields in this lower-for-longer rate environment has become more challenging with a slower-growing global economy and several intensifying geopolitical issues, such as the US-Sino trade war, Brexit and ongoing unrest in Hong Kong and the Middle East. Political uncertainties continue to dampen investor confidence and companies continue to keep investments on hold. Overall, these risks translated into higher volatility in all traded markets throughout the above reporting period, while easier monetary policies ensured positive returns across most asset classes.
With the return of quantitative easing (QE) and rate cuts, the amount of debt with negative yields also increased dramatically. The US 30-year Treasury set all-time lows in yields, dropping below 2% for the first time by the end of this reporting period. Negative yielding debt globally exceeded $17 trillion by the end of this period, which is a record as well. Such unconventional developments in fixed income have forced investors to take on more risk in their search of positive real returns. In this respect, we extended our corporate overweight focusing on sectors or names that we believe still have some spreads to offer. Considering this, we continued to favour financials given that as a whole they have been largely improving their balance sheets since the global financial crisis and are less directly exposed than industrials to the developing trade tensions. We also remained biased to certain insurance firms which had been indiscriminately hit hard in last year’s sell-off and increased our allocation to selected credits via new issues (e.g. Orange, Merck, Berkshire Hathaway, Fidelity National Information Services).
In Q2 we added some duration closer to the benchmark while also retaining our overall short positioning. Given the low-yield environment, we have been eyeing opportunities across the corporate credit spectrum and while we have not invested in BBBs more than usual, we have been happy to move down the capital structure in our search for more attractive spreads, as long as we are comfortable with the company’s credit risk profile and financial strength moving forward. Indeed, as assets continue to be buoyed by the expectations for prolonged monetary accommodation, corporate bonds have outperformed government bonds (like in 2017) and our investment grade credit holdings contributed positively to the Fund’s performance during the above period. With yields dropping or near record lows, we have preferred to seek spreads down the shorter duration route rather than in longer duration bonds. In this regard, we did not benefit from the fall in long-term interest rates like the Benchmark did.
Road to 2020
Given the increasing amount of debt in the system and the growing disconnect between market prices and fundamentals, we will remain cautious and defensive in our asset selection. We believe the Fed’s next move will stem more from global ‘cross currents’ and a potential risk of trade-related tightening in financial conditions. While unemployment data in the US remains the best in 50 years, cracks in the global economy are becoming more evident. More than a year on now since the US first imposed tariffs on Chinese exports, the impact of these ongoing trade tensions on the manufacturing sector (particularly in Europe) is also becoming harder to ignore. Whilst employment numbers continue to go from strength to strength, the pass-through from higher wages to higher inflation is failing to materialize and there are the lagged effects of higher interest rates as well as a stronger dollar impacting investments and personal consumption.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s).
Canada Life Investments is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
CLI1522 Expiry on 31/12/2020