For many, 2020 has been a year of significant uncertainty from both public health and economic perspectives. Since the initial wave of financial market instability in March, we have seen equity and fixed income markets swing in response to changes in pandemic projections, US presidential election probabilities, corporate earnings, China-US trade negotiations, macroeconomic data, corporate headlines, and even Tweets. Some of these factors should rightly influence asset prices, others less so. The narratives which seem to have had the greatest effect on asset prices year to date have been the pandemic’s damage to “normal” economic activity and the status of the ongoing China-US trade negotiations.
The Federal Reserve responded to market volatility in mid-March with unprecedented swiftness, dusting off their entire playbook from the 2008 crisis as well as creating several new facilities to support market liquidity, all in the span of roughly two weeks. They quickly reversed course on letting assets roll off their balance sheet from prior Quantitative Easing (QE) and instead ramped up purchases of mortgage backed securities and US Treasuries. These actions, along with facilities designed to backstop segments of the municipal and corporate bond markets, did much to quell investor concerns and put a floor under asset prices. The question that remains is: what now? The Fed has pulled out the proverbial bazooka and done virtually everything possible within its mandate (and beyond) to help support markets. Should further market weakness occur, it seems likely the Fed will provide additional support, which leaves investors in an uncertain position with regards to properly judging risk and potential return. The Fed and government are “all-in”, time will tell whether they have more ammo to support asset markets.
The Barclays Aggregate Bond Index has risen just under 7% this year, largely driven by a global search for “safe” yield in US Treasuries. When breaking this down further, we see that the best performing sector within the bond market has been long-term US Treasuries, up north of 20% for the year as of this newsletter. Long-term US Treasuries comprise around 30-40% of the Barclays Aggregate Bond Index, which means that this one part of the market has contributed the lion’s share of returns for the Index in 2020. US and European High Yield bonds both fell in tandem with equities (correcting down over 20%) but have now recovered to be slightly down, and down 2.5% year to date, respectively. With the sharp move downward in global interest rates sparked by the Fed’s emergency maneuvers in March, many of the high-quality areas of fixed income experienced price appreciation driving them to expensive valuation levels – in particular long-term US Treasuries. This has not deterred investors from continuing to put money to work in those areas, as safety has become a major priority for a large percentage of investors and many market participants expect rates to stay low for the foreseeable future. After hitting extremely weak levels in March, the aggregate high-yield and investment-grade bond indices have recovered approximately 30-50% of the credit spread widening we witnessed in March. Bank loans and emerging market debt have remained weaker as they have some structural issues remaining which make them less attractive relative to other areas of the bond market.
So, what does all this mean for fixed income markets going forward? No one can know for sure. The stock market rally which began in late March has temporarily stalled several times over the past couple of months as pandemic data worsens and macroeconomic data slows back down, only to continue its climb higher on the strong momentum that is currently driving this market. The energy, retail, gaming, leisure, and hospitality industries are all still reeling from the effects of the COVID-19 pandemic, with no sure sign of relief on the horizon. The winning sectors of the recent past have continued their dominance, specifically in higher growth tech names as well as a new breed of “Work from Home” related goods/services. We continue to monitor these markets closely to ensure we navigate the choppy waters as smoothly as possible. Now is not a time to reach for additional risk or yield, it is a time to make sure that portfolios can weather the uncertainty ahead and that the fixed income portion of the portfolio should balance income needs with relative safety and stability.