The 'year of bonds' is almost over, but there's still hope in US markets

REUTERS/John Gress

In many ways, 2016 has been the year of bonds, at least so far: Global aggregate bond markets have outperformed global equity markets year to date. That leaves many investors wondering if bonds still offer value, given their low yields.

Though investors may need to get used to lower returns on bonds, this does not mean they should give up on them; we believe there are still many bond market sectors and securities offering attractive return potential as well as diversification benefits. However, the current environment of lower bond yields means investors need to be more selective and also need to consider reducing interest rate risk. The U.S. corporate bond market continues to be one of the main areas offering much-needed yield, especially given our long-term outlook for continued global demand for income-producing assets – a tailwind likely to help support prices.

The search for yield amid this appetite for income is complicated by the reality that almost $12 trillion in bonds in the Barclays Global Aggregate Index are now at negative yields (see chart), including more than 80% of Japanese and German government bonds. As the European Central Bank and the Bank of Japan continue with ever-increasing unconventional policies, such as negative interest rates and large-scale asset purchases, local investors are faced with the challenge of finding income in a world of negative-yielding government bonds and low-yielding corporate bonds in their home markets. They are consequently looking further afield, and this has resulted in a wave of investment into U.S. corporate bonds.

REUTERS/John Gress

Even after this year’s rally, we believe investors can still seek potential yields of 3%–6% in the U.S. credit markets by investing in investment-grade and select high yield corporate bonds, bank loans and non-agency mortgages. Among major developed markets, Japan and Europe are barely growing, but the U.S. should be able to grow at roughly 2% over the coming year. Therefore, from a fundamental perspective, we are favoring the U.S. credit market, along with U.S. domestically-focused businesses.

While we have reduced exposure to select credits in the U.S., we are maintaining overweights to U.S. credit across most portfolios. We remain very constructive on housing and many consumer-related sectors, such as cable, telecom, healthcare and gaming. And even though there’s a lot of pressure on banks at the moment, U.S. bank bonds are actually very attractive. We also like energy: We added to our energy positions back in January near the market lows, and we still like pipelines at current levels.

The positive outlook for the U.S. bodes well for credit assets in industries and sectors supported by high barriers to entry, above-trend growth and pricing power, in addition to companies with management teams that act in the best interest of bondholders. With a large credit research and analytics team, we can still seek and find many companies with these characteristics – and these days, many of them are in the U.S.

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