Strategic Fixed Income: more divergence and disruptions in 2018



Co-Head of Strategic Fixed Income, Jenna Barnard, looks back at 2017, while sharing her thoughts and views on the major themes likely to affect credit markets and the Strategic Fixed Income portfolios in the coming year.

Key points:
  • The failure of consensus bond thinking — yet again in 2017
  • Key themes impacting credit markets in 2018: a continuation of divergence and disruptions
  • Wage inflation, should it surface, by far the biggest risk to all bond asset classes

Video Summary

Lessons learned from 2017?
2017 for me was the perfect example of the failure of consensus bond thinking. So everybody came into the year, in January, expecting higher government bond yields, thinking that there was going to be a regime shift to higher growth and higher inflation in the US economy, and yet again failed. Inflation peaked in February* and collapsed afterwards and we’ve seen no signs of wage inflation, really in any developed market economy that has low unemployment.

So based on the experience of 2017, John and I actually went back and looked back at how many times consensus has been wrong on government bond yields, and we actually found that in the last 26 years, 24 of those years, consensus has forecast higher government bond yields**. There’s only been two years when they forecast lower bond yields. And I think that is endemic in our industry and it explains the underperformance of many areas of active fund management. Really, it’s just a huge misforecasting that goes on year, after year, after year — unchecked.

*US inflation **10-year US Treasury yields, Philadelphia Fed Survey of Professional Forecasters, as at June 2017

Key themes for your markets in 2018 and portfolio positioning implications?
I think the key theme for credit markets today and going forward is divergence – and disruptions. We’ve seen huge amounts of industry disruption, which is causing problems for certain corporate bonds in our market. Technology is obviously a huge source of disruption and we see that in the retail sector, most obviously. But we also see for example the beer industry in the US being disrupted by the rise of cannabis as an alternative, and obviously the small craft brewers. So, it feels to us actually that we are kind of being squeezed out of many industries that we would have invested in historically, because they are becoming too unpredictable for us and there is a lack of top-line growth. As a result equity valuations are starting to suffer. So I think that disruption, that divergence, and being really strict in terms of who we lend money to, is the key theme for us; and it is getting more difficult.

Key risks and opportunities for 2018?
By far the biggest risk to all bond asset classes is wage inflation. If we see signs that this low unemployment that we see in the UK, the US, Germany, Japan, results in wage inflation, then central banks are back in play and we’ll have much faster interest rate hikes. So far, we don’t see it. The Phillips curve is completely broken down. Economics as a discipline is really under question – in the real world – but if it did come into play in 2018, that would be the prime risk, as I said, for all bond markets.

In terms of the opportunities for us, we actually think the bigger opportunity is in government bonds. Australia is a very interesting, very divergent economy. So we like the government bonds in that market. I can talk about that in more detail if anyone is interested. And the US, actually; the economy there feels quite late-cycle to us. So we are actually looking for buying opportunities in government bonds, and credit markets. As I said earlier, we are going to maintain the discipline and I think just keep reducing the riskier credit in portfolios.


Bond yield: the level of income on a security, typically expressed as a percentage rate. Note, lower bond yields mean higher prices and vice versa
Credit markets: a marketplace for investment in corporate bonds and associated derivatives
Top-line growth: refers to an increase in the gross sales or revenues of a company (as opposed to the bottom-line, which refers to net earnings or net profits)
Phillips curve: a curve representing the long-term relationship between unemployment and inflation in an economy, used as a tool in the analysis of macroeconomic policy by central bankers
Riskier credit: corporate bonds exposed to higher risks
Inflation: the rate at which the prices of goods and services are rising in an economy. The CPI and RPI are two common measures.
Late-cycle: economic recovery in the US reached its eighth year in 2017 — one of the longest economic cycles in the US. Low unemployment and healthy economic growth have historically led to a rise in wages, core inflation and interest rates; however, low levels of growth and inflation have extended the cycle.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

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