Nick Maroutsos, co-portfolio manager of the Absolute Return Income Strategy, sees the potential for greater volatility in 2018 as bond markets contend with central bank policy moves and political risks.
What lessons have you learned from 2017?
This year has taught us that fixed income managers must be more aware than ever of the macroeconomic and geopolitical landscape. Like US dollar strength, global bond yields have been a barometer of the markets’ faith in the Trump administration’s economic plans. We have also learned that we must be aware of the breakdown of the historical relationship between employment and inflation. The US may be close to full employment as strong payrolls data, fewer job openings and ‘quit’ rates point to a strong labour market. Nonetheless, inflation remains well contained, as wage inflation remains low, driven by weak labour bargaining power.
What are the key themes likely to shape the markets in which you invest in 2018 and how is this likely to impact portfolio positioning?
A theme we are closely watching is the potential for greater volatility. Consequently, we expect duration positioning to be an important factor in managing fixed income portfolios in 2018. We believe that a bias towards minimising duration (interest rate) risk is likely the most prudent path.
Valuations across many asset classes reveal that a favoured theme of the market is the expectation of pro-growth reform in the US. We are more cautious. We believe the Trump administration’s plans will continue to be delayed as internal missteps and controversies cause ongoing short-run volatility.
We believe the European Central Bank (ECB) will continue to struggle with the effectiveness of its quantitative easing programme. We expect European growth and inflation to continue to remain weak by historical standards amid structural rigidities in the labour and product markets, particularly in peripheral regions.
Where do you currently see the risks within your asset class and where are the most compelling opportunities?
Despite the low growth, low inflation and easy monetary policy, we have found bond opportunities limited given low/negative yields and the risks associated with higher-yielding investments. We also see a material risk that Washington will continue to fall short in implementing a pro-growth agenda and any legislation that does pass will be insufficient in creating an environment conducive to durable, long-term growth.
We expect to continue to avoid Europe, given uncertainty surrounding the Brexit campaign, low yields and limited corporate profitability. We are particularly concerned about the European banking sector, which has historically done little in raising new capital or writing down bad debts.
We continue to favour Australian rates versus the rest of the world, particularly as Australian bonds underperformed the US in the third quarter. We expect the Reserve Bank of Australia (RBA) to remain on hold well into 2018.
We also like systemically important, highly rated Asian issuers, such as government-related energy, telecom and banking entities and the US “too big to fail” banks, whose bonds should be supported by an increasingly robust regulatory environment focused on less risk taking and greater capital requirements.
These are the manager’s views at the time of writing and should not be construed as investment advice.