The House Isn’t On Fire
At Northern Trust Asset Management, a large investment portfolio would typically be fully invested or overweight in most fixed-income asset classes, says Colin Robertson, managing director of fixed income at the firm. “We don’t think the house is on fire so we wouldn’t invest in cash,” he says, although a small allocation is OK.
Heading into 2019, Robertson thinks the fixed-income markets are a much better place to be, on a risk-reward basis, than equities. Equities are volatile and pretty elevated, he says, though he doesn’t expect a stock crash.
Northern Trust doesn’t think the Fed was dovish enough at its December meeting. Robertson and his colleagues expect economic data to soften because of a weakening global economy (particularly in China and Europe), because of “stuckflation” worldwide (inflation is below 2% in most countries), because of the natural waning benefit from the recent U.S. tax cuts and because of the trade issues with China and other nations. According to a Northern Trust review, the credit markets in aggregate also seem to be in “solid condition.”
“I think the Fed has gone too far too fast,” says Robertson, whose biggest fear is an inversion across the entire yield curve. He thinks a couple of the 2018 hikes were justified by strong domestic growth, which he had underestimated. But the Fed overestimated inflation based on “their hope, not on their facts,” he says.
Northern Trust Asset Management thinks high yield presents attractive opportunities this year. Although the firm is cautious when selecting individual bonds, it likes the financials sector here. Valuations are good, default rates are relatively low, and “there aren’t a lot of entities with a bunch of debt coming due or stressed leverage ratios that would make it look like they could fall out of bed and be problematic,” says Robertson.
Ultra-short fixed income (instruments with an average duration of six to 15 months) offers some income stability and “sleep-at-night money” in this volatile environment, he says. With such a flat yield curve, investors don’t have to sacrifice much yield by being in the shorter end of the curve instead of in the longer end of the curve. Ultra-short securities can be exited quickly if rates rise—though they shouldn’t be used as a substitute for cash, Robertson says.
Mark Heppenstall, the chief investment officer at Penn Mutual Asset Management, anticipates a “return to Goldilocks growth” in GDP, around 2.5% this year, he says. The rapid decline in oil prices will put some downward pressure on inflation, keeping it around 2%, he says.
He expects higher swings in asset prices as markets readjust to curtailed purchases of financial assets by central banks and pockets of stress in parts of the globe. The problems in Italy could affect risk assets elsewhere and the country could pose a much bigger problem than Greece did, he says.
To add value, Heppenstall, who advocates being nimble and opportunistic, is taking advantage of spread-widening events. “We think you’re getting paid now to own some degree of interest rate risk, especially in that five- to 10-year corporate-focused part of the market,” he says.