January is normally the month in which investors look at their portfolios and decide what they want to do over the year. Unfortunately, the market is not giving them many easy options at the moment. While the majority of available bonds repriced last year, it doesn’t seem as though they have hit bottom. Rate hikes might be on hold for now, but still the world is facing a considerable economic slowdown that will inevitably translate into a deep repricing in both the equity and the fixed income markets.
Investors should not be discouraged, though, as moments like this are also the ones in which opportunities arise. Already now, it is possible to find interesting companies offering good yields that were unthinkable just one year ago.
Last week, we looked at emerging markets and concluded that the risk-opportunity offered by these bonds offer is contained, and better value can be found within the US corporate space.
We have mostly looked at USD-denominated bonds for the simple reason that, since interest rates have started to rise, yields across all sectors have also softened. This has cleared a path to entering high-quality names with higher yields than seen in previous years.
We have rarely looked at the euro area because yields there have been low for so long that these investments did not ordinarily make much sense, offering little in terms of return. Similarly, with Brexit destabilising the UK market, risky assets in Britain have been neglected for some time. Now that it appears as though we may be headed towards some resolution on Britain’s exit of the European Union, though, it may be time to take a second look at this space.
Sterling is receiving more and more attention from FX traders. Since the Brexit vote, GBP has fallen to historic lows and now that we are approaching a resolution, investors are forecasting a turn higher for the UK currency. At this point, any type of resolution would be welcomed; that said, it appears as though a hard Brexit is increasingly improbable. This means that USD- and EUR-funded investors have the opportunity to buy bonds in a undervalued currency and benefit from the yield that this space may offer.
Corporate spreads have been tightening since the Brexit vote. This has been provoked by investors fleeing to safety as volatility spiked in the equity market after the ballot. However, this trade has changed since the beginning of last year, when we started to see corporate spreads undergoing an important widening caused partly by the underperformance of the high yielding space, which remained particularly sensitive to the possibility of a hard Brexit, and partly caused by the August Bank of England rate hike.
Also, global headlines concerning the trade war between China and the US have contributed to the declining value of the high yield space.