“With credit spreads still tight, consider moving into the safer parts of the credit spectrum and focus on shorter maturities. After recent price declines, we believe that EM corporate bonds are attractive again..””
– Eli Lee, Head of Investment Strategy, Bank of Singapore, Member of OCBC Wealth Panel
Along with less bearish investor sentiment, there appears to be some stabilisation in the Emerging Market (EM) universe. The problems in EM do not look systemic. The economic imbalances are not widespread and limited to the likes of Argentina and Turkey.
Growth across EM economies appears solid and, from a bottom up basis, corporate balance sheets have demonstrated improvement over the past several quarters with default rates still below historical averages. In recent months, spreads for EM high yield bond have widened considerably but spreads for Developed Market (DM) high yield bonds continued to trade at very tight levels. On a relative valuation basis, we have a strong preference for EM over DM high yield bonds. As a result, from a tactical asset allocation perspective, we are turning underweight on DM high yield bonds from a neutral position.
EM high yield bonds did well in September
EM bonds notched a solid gain in a non-eventful month in September which was probably a relief to fixed income investors weighed down by a seeming tidal wave of political headline news throughout the year. The JPM EM CEMBI Broad index rose almost 0.8% , the second positive result in the past three months with high yield bonds up a strong 2% and investment grade bonds down 0.1%.
Positive outlook for EM bonds
We consider September a fair representation of how we expect EM corporate bonds to play out over the coming months. The asset class is supported by the tailwinds of adequate economic growth, company specific operational performance that has afforded balance sheet reduction over the past several quarters and more compelling valuations. However, this is balanced by the headwind of rising rates with the net result of the two forces a modest positive gain for EM corporate bonds, with the less interest rate sensitive high yield bonds outperforming investment grade bonds. Absent further political histrionics and volatility, we would expect this trend to play out for the remainder of 2018.
Within the bond segments, we are most positive on EM high yield bonds. In terms of the region, Asia is sour favourite region driven partly by China. Amidst slowing economic growth exacerbated by rising trade tensions, China has started to reflate domestic demand via monetary and fiscal measures. China is also largely insulated from the political headline noise that has embroiled much of EM during 2018.
The quest for carry with EM bonds
We believe one of the best carry opportunities can be found in the Emerging bond universe. Fears of EM contagion from Turkey and Argentina appear to be overdone. This presents an opportunity for investors looking to find solid EM bonds with good carry. Economic and corporate fundamentals in EM are healthy. With the price correction in recent months, we believe that valuations for EM high yield bonds appear compelling. With Dollar strength waning and the US10-year Treasury bond yields entering a range of 3.0 to 3.3%, adding EM high yield bonds into one’s portfolio for carry is a good strategy.
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