Neuberger Berman explains reasons why investors should remain overweight credit
Neuberger Berman’s Global Fixed Income team believes that credit is an undervalued asset class across the major currencies and remains overweight.
In Q3, policymakers continued to devise plans and introduce new rounds of stimulus aimed at supporting growth and returning markets towards normalization. Global economic data has continued to deteriorate, adding credence to the argument that implementing ambitious austerity programs in a fragile growth environment poses a considerable threat to economic expansion. While we acknowledge that global bond markets will remain in a relatively low interest rate environment, we feel that yields should rise modestly above historically lows, and thus we continue to be underweight duration in portfolios. Additionally, we believe that increased monetary stimulus by central banks and promised easing in 2013 support a steepening yield curve position in most developed bond markets.
By the same token, exceptionally low long-term interest rates may trigger increased inflation expectations, and thus we advocate having some inflation protection in portfolios. However, particularly in the U.S., we would look to add exposure opportunistically given September’s aggressive widening of break-evens post the FOMC’s QE3 announcement.
Over the past year, we have maintained that there was considerable room for spread compression between higher yielding countries (i.e. Australia and New Zealand) and markets aggressively priced for a double dip outcomes (U.S., Germany, and Japan). While we began to take profits in Q2 due to aggressive spread compression, recent spread widening has made this trade relatively attractive again and we began to tactically rebuild our position towards the end of Q3. Lastly, In Europe, we continue to carry a reduced position, with a steepening yield curve bias in Core Europe and a flattening yield curve position in the periphery.
As has been the case for more than 2 years, the European debt crisis will remain a major determinant of price action in global bond markets in Q4. While Draghi defiantly stated that the ECB would “do what it takes…believe me it will be enough”, investors continue to be skeptical as European leaders remain largely divided on the best way to contain the crisis. Political friction between core and the periphery has reached alarming levels, and while the German Constitutional Court allowed ESM ratification to go forward at the end of Q3, Germany remains a reluctant participant in bail-out efforts. Moreover, rising social tensions and austerity fatigue in the periphery also serve as downside risks. While the ECB has stated its willingness to engage in further purchases, associated conditionality is likely to raise hostilities even further particularly in light of rapidly deteriorating economic fundamentals. The idea of “Eurobonds” continues to look like the most credible solution to the crisis, but crafting a remedy that satisfies 17 disparate nations remains a convoluted and time-consuming exercise. Recent months have shown that policy paralysis poses an immediate threat to the survival of the Euro in its current form and policymakers can be certain that investors will be eagerly anticipating tangible progress to emerge in Q4.
In currencies, the impact of potential future reserve diversification flows remains one of the most difficult variables to predict. The shortage of high quality liquid assets denominated in currencies that are not extremely overvalued makes it hard to anticipate how Central Banks and sovereign wealth funds will deal with their diversification requirements in the future. Additionally, many of the AAA countries are unlikely to welcome the currency strength and the volatility caused by large diversification flows. Fiscal policy remains constrained in all the major economies. Because of this, it is likely that monetary policy and unconventional measures adopted by the major central banks will continue to have a significant impact on currency valuations in the coming months. In this context, we do not expect a break-out of the recent trading ranges until the growth path of any of the major countries starts diverging substantially from the others. For this reason, for now, we prefer focusing on tactical short-term opportunities and we expect our portfolio composition to continue to be relatively dynamic.
Over the quarter, we continued reducing risk in our corporate credit portfolios into the rally, locking in some of the gains and looking for relative value opportunities. We continue to believe that credit is an undervalued asset class across the major currencies and we remain overweight, as we expect spreads to tighten over the months ahead, albeit punctuated by periods of volatility.