We are only a few weeks into the new year and already there have been a number of events that we classify as remarkable in nature, which will have long lasting effects on financial markets.
An eventful year
We have experienced fires, storms, an impeachment enquiry, a Brexit vote, Presidential debates and the threat of a widespread new virus all before the first month of 2020 comes to a close.
The widespread risk market sell off earlier this week highlighted that despite trading at record levels markets remain jittery. Given we are late in this cycle, investors appear keen to take any opportunity to crystallise gains.
Uncertain market sentiment – economies, climate and health
At the January FOMC meeting the Federal Reserve noted that the hurdles for an official rate hike remain high while indicating that the central bank is willing to stimulate the US economy at any cost, if required. The underlying data coming out of the US is relatively benign, showing a “goldilocks” scenario where the economy is neither too hot nor too cold. It is a combination of these two factors (an accommodative Fed and a benign economy) that are supporting strong US equity valuations, and lower borrowing costs are resulting in higher amounts of corporate borrowing. In the US alone over USD73bn of high yield (HY) bonds have been issued so far this year.
The US is well and truly into the election cycle as well as the Presidential impeachment trial. The markets will be closely watching any changes to policy measures announced by the Presidential candidates as the race tightens to analyse the likely impact of these policies on the economy.
The other closely watched indicator in the US is the Federal Reserve’s balance sheet, which has been buying USD60bn of T-bills a month since September 2019. This asset purchase by the Fed (also known as quantitative easing or QE) has also been supportive of risk asset prices.
Domestically, a stronger employment data print has resulted in most economists moving their RBA rate cut expectation from February to April. However, despite strengthening employment, inflation and economic activity remains low. The latest CPI print showed that annual headline inflation rate for Q4 2019 edged up 0.1% to 1.8%, but remains below the RBA’s target range of 2.0%-3.0%.
The total impact of the widespread bushfire crisis is yet unknown but what we do know is that more than half of Australia’s population has been directly affected by the fires. It has widespread ramifications for a variety of companies from airlines to insurers.
The more interesting development from the bushfire crisis is the rising global awareness around climate change and the impact this is having on companies that do not currently have a focus on sustainability. We suspect these companies could face potential future losses and higher funding costs if an appropriate plan is not acted upon in a timely manner.
Globally, we are bracing for the fallout from the recently discovered coronavirus, which covers the broad family of viruses such as SARS. As the first chart above shows, markets do not yet know what to make of this event. While the virus has infected more people than those infected by SARS, it appears to have a lower mortality rate (based on what we know so far). This is an unfolding story and it is unlikely that we will have a solution for this issue in the short term.
What does this mean for investors?
At the risk of sounding like a broken record, it is important to remember the importance of diversity in a portfolio. A portfolio should include both investment grade and high yield bonds, if your risk appetite can accommodate currency risk then foreign currency bonds are also a good addition to portfolios. Furthermore we encourage diversification by industry, seniority and coupon type as well as a spread out maturity profile. The reason for this is to cushion portfolios from any bond or industry specific risk.
We currently have a number of bonds available that present strong relative value in the current trading environment. Please contact your Relationship Manager to discuss these opportunities.
Earn over 6% pa* with Corporate Bonds.
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