Finding fixed income opportunities in new paradigm

Glenn Freeman  |  02/08/2017Text size  Decrease  Increase  |  
email_fwd

Vincent Reinhart: The big picture, just stepping back, that just about everyone should appreciate about the economic landscape is, in advanced economies potential output growth is slowing.

We are older populations; we are growing less quickly; we are participating less in the organised labour market and we are not adding as much extra output for each extra hour worked. That's slowing.

We are also slowing not just over time but relative to emerging market economies. There is growth out there. It's in China; it's in India. The relative footprint of emerging market economies is growing relative to advanced economies. 30 years ago, we were talking closer to under 40 per cent. Now, we are talking about 60 per cent of world real GDP takes place in the places we call emerging markets.

So, there's a couple of aspects of that major force potential output growth slowing. One of it is as EM gets bigger, they need us less. And so, in the 2000s, emerging market economies were running very large current account surpluses, i.e., they were buying the securities of advanced economies. That's allowed us to run current account deficits, i.e., bringing in more goods and services than sending out, means you have to be increasing IOUs.

What's happened over the last couple of years is, emerging market economies current account surplus has moved into deficit. They are funding themselves, not us and that's a problem for advanced economies over time because we still have large levels of government debt, we still have deficits. Advanced economies as a total are running budget deficits of 2 per cent to 3 per cent, relative to their gross domestic product. That means they got to sell those securities to somebody, less so to emerging markets than before.

So, obviously, it's a losing proposition to make forecasts about currencies, but there are some basic forces at work that may at least give you a sense over the medium and longer-term where currencies should go.

And again, it goes back to that feature – advanced economies growing more slowly than emerging market economies. If your potential output growth is slower, real rates are lower, too, because how fast your potential output growth is, determines the profile of how fast households think their future income will grow.

If you expect your income to increase less, you should save more. Firms, profile of expected future earnings, if they expect less earnings in the future, they should invest less. Market outcome, more savings, less investment, lower real rates. So, that's lower real interest rates in advanced economies, higher real interest rates in emerging market economies.

That's a recipe for secular appreciation in the exchange rate of the emerging markets relative to advanced economies. We think in terms of the US dollar, mostly the depreciation, we've seen in the last couple of months against the centers, Europe, Japan are behind us. We move sideways. There's still a little scope for the dollar to depreciate against emerging market economies. It's where real rates are higher and it's where there's more scope for delivering better policy.

When you're talking about credit, you are also talking about careful. You have to be selective. And that's importantly, because a lot of the opportunities have already been eroded away.

Risk spreads whether for high-grade corporate or high-yield corporate, have shrunk a lot. Risk spreads in emerging market sovereigns have shrunk a lot. And so, there are still some spreads out there but you have to be really careful.

You have to be selective. We think looking at current valuation, there's probably better values relatively in US high-yield than in corporate. When you're talking about high-yield, you have to be selective.

I always go back to this same point. Potential output growth is slowing? How come? Advanced economies had aging populations, participating less and less in work. That means that those people as investors have to appreciate that they need a more secure set of returns. And so, fixed income should be an increasing proportion of a portfolio as you get older, because you want to be able to have a more predictable stream of future income.

Video Archive...

Should investors be concerned by North Korea?
25/09/2017  Mark Williams, manager of the UK-based Liontrust Asia Income fund, talks about Kim Jong Un, Donald Trump, and the impact on stock market returns.
Did lack of transparency cause the financial crisis?
19/09/2017  Ten years after the collapse of Northern Rock, Andy Agathangelou tells Emma Wall that greater transparency in financial services could ward off a second global financial crisis.
Are we facing another Global Financial Crisis?
19/09/2017  Ten years on from the collapse of Northern Rock, Dan Kemp tells Emma Wall how there are echoes of the crisis in markets today.
Wild ride in FY17 and more to come - part 2
13/09/2017  Morningstar's Peter Warnes discusses how you may want to position your portfolio in FY18, as geopolitical storms continue to rage and safe-haven assets feel the effects.
Wild ride in FY17 and more to come - part 1
12/09/2017  Cost-out remained a dominant theme for large-cap Australian companies in FY17, and looking ahead to FY18, they should be clearer on cap-ex, says Peter Warnes, Morningstar’s head of equities research – Australasia.
Deeper demand driving these pooled investments
31/08/2017  Listed investment trusts are beginning to take off in Australia, but exactly what are they and how do they differ from listed investment companies and managed funds?
Upbeat Woolies result tempered by Big W
30/08/2017  Woolworths' category-topping FY17 result driven by surprisingly strong sales, even as sector faces tougher times ahead, explains Morningstar's Johannes Faul.
Coke Amatil 1H17 result leaves margin of safety
28/08/2017  A challenged earnings announcement from Coca-Cola's Australian-listed business was largely expected, but downside is already priced in and improvements are expected in FY18.
How slashed Telstra dividend affects our outlook
23/08/2017  Brian Han remains reasonably positive on the telco giant even after some disappointments in the FY17 earnings announcement.
Earnings season FY17 mixed bag so far
18/08/2017  Aside from a few high-profile earnings guidance misses, large-cap stocks are doing okay as FY17 reporting season passes halfway, says AMP chief economist Shane Oliver.
Rio Tinto posts mixed result for 1H17
10/08/2017  An interim result of US$3.9 billion in net profits after tax for one of the world's largest mining companies was positive but slightly weaker than expected, even alongside a record dividend, explains Morningstar's Mat Hodge.
Kerr Neilson on why global investment exposure is key
07/08/2017  There are two types of investors, regardless of market noise, imputation credits, diversification approaches and market indices, says the managing director of Platinum Asset Management.
Finding fixed income opportunities in new paradigm
02/08/2017  Slowing economic growth in the US and parts of Europe emphasises the need to carefully select credit opportunities, says Vincent Reinhart, chief economist, Standish Mellon Asset Management.
Telstra won't be blown away by headwinds
17/07/2017  While it faces what Morningstar equity analyst Brian Han describes as a whirlwind of negatives, he suggests investors shouldn’t hang up on Telstra.
The home-truths of investing
12/07/2017  Look for companies that sit outside the cycle; heed the lessons of history; and remember the power of compounding, says Bennelong's Neale Goldston-Morris.
Self-managed super is not Do-it-yourself
03/07/2017  There are a few common pitfalls in running a self-managed super fund that mean trustees shouldn't go it alone entirely, says BT Financial Group's head of financial literacy, Bryan Ashenden.
Investing to protect on the downside
30/06/2017  There are investment strategies you can adopt to mitigate volatility-linked fear and uncertainty in markets, explains Roy Maslen, chief investment officer – Australian equities, AllianceBernstein.
Don’t overdo benchmark consideration
28/06/2017  Being benchmark agnostic is the most effective approach to fixed income investing, according to Anujeet Sareen, portfolio manager, Brandywine Global.
Factor-based investing using ETFs
26/06/2017  Investors should consider style-exposures--such as value, defensive or yield-- they would like in their portfolios, explains Jonathan Shead, head of portfolio strategists – Asia Pacific, State Street Global Advisors
Volatility plays to active manager strengths
--  The climate of political volatility in the US holds important implications for investors and the funds they invest in, particularly around Donald Trump's ability to pass legislation through Congress, says Pimco's Libby Cantrill.