Comments from Nick Gartside, International Chief Investment Officer for Global Fixed Income at J.P. Morgan Asset Management.
Summer markets at last? Well, let's see, there are a number of worrying clouds on the horizon:
1. Growth. Or more precisely lack of growth. Eurozone Q2 GDP printed over the week at a measly 0.2%. That's pretty much in line with the lacklustre growth seen in the UK and US. Looking further afield our proprietary leading indicators for the emerging world continue to point downwards and our EMD team feel that the risks are skewed to data printing lower, not higher, than expectations. There are glimmers of hope: US Initial Jobless Claims and retail sales both surprised to the upside, but it is likely that central banks will soon be battling to prevent economies slipping into recession.
2. Eurozone. The debate around ratifying the EFSF is intensifying and news flow around this could well flare up in the coming weeks. In any event, the proposed size of the EFSF at €440bn remains too small. The solution remains a common Eurobond; judging by recent comments from political leaders these are some way off. Greece could also re-emerge as a topic for markets as we approach the next quarterly review in the autumn. Expect peripheral Europe to come under pressure as we enter September.
Both these factors, coupled with underweight positioning, augur well for government bonds. Over in riskier fixed income sectors last week's dramatic dislocation did cheapen markets and create value:
High Yield looks pretty good. In Europe the percentage of the all in yield that is now represented by the credit spread, around 82%, is close to the peak levels seen at the end of 2008.
Local EMD also offers value. Although outright yields at around 6.5% are close to the lows of 6%, as a spread to 10yr US Treasuries local EMD at 4.5% is at its widest levels for a few years.
However, there does remain a tension between attractive valuations, and the potential for economies to double dip and slip into recession. Our sense is that central banks will lean hard against a double dip and will deploy more tools to prevent one. A low growth environment is good for these assets; a recessionary and risk aversion environment is disastrous.
What are we doing in portfolios?
Any sailor knows the doldrums are characterised by violent, sudden changes in weather. Markets could well behave the same way as we conclude the vacation season as the cross currents from macro issues, poor liquidity and investor nervousness collide.
The overall backdrop of anaemic growth is a favourable backdrop for fixed income markets and we're sticking with long duration positions - the clear message from the Japanese experience is not to fight low yield levels. We're also selectively starting to add to high yield. This is a market where differentiation between issuers is likely to increase. Where our team of credit analysts has high conviction we're adding names to portfolios.
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