Credit strategies supported by growth as developing markets struggle
Globally, we think economic growth remains on track, led by the United States. As a result, we believe the stage is set for bond yields to rise. We don’t think rising yields will be a major disruption to asset markets. In our view, investors appear to be more comfortable with the idea that risk-driven assets can perform reasonably well even if rates move higher.
In fixed-income markets, we continue to favor mortgage credit, prepayment risk, and corporate credit, but are taking a somewhat more conservative approach than previously. We are doing this by purchasing securities with less price sensitivity to changes in yield spreads, while also seeking greater credit protection by investing at more senior levels in a deal’s credit structure. Our corporate credit holdings — primarily high-yield bonds — were the biggest contributor to third-quarter returns. The asset class performed well amid improving U.S. economic growth; strong second-quarter earnings reports; softening trade tensions between the United States, Europe, and Mexico; and the lightest net new issuance since April 2009. Mortgage-credit strategies also aided performance.
Emerging markets: Hampered by economic, political risks
Bonds issued by the government of Argentina sold off in late August after the country’s president petitioned the International Monetary Fund to expedite $50 million in emergency funding. Uncertainty surrounding upcoming elections in Brazil hampered the performance of that country’s debt. Emerging-market debt rebounded in September, as investors sought to capitalize on newly attractive valuations created by the volatility in August.
U.S. economic growth, and the Fed’s response to it, has placed pressure on international markets, particularly in developing countries. Assets have flowed out of emerging markets and into the United States in search of better risk-adjusted returns. The dilemma facing policy makers in less-developed countries is whether to try to keep pace with the Fed as it raises interest rates. Higher rates could help stem capital outflows from emerging markets but could also crimp domestic growth.
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The outlook for global economic growth is easing because of protectionist tariffs, weakness in emerging markets, and rising oil prices.