Bonds, like all financial asset classes, are very expensive by any historical yardstick, observes Bob Michele, CIO of global fixed income and commodities at JP Morgan Asset Management.
Still, there is some good news lurking behind the lofty stock and bond prices, not to mention the razor-thin yields. There is “a 60% probability [that] over the next six months the markets will price in above-trend growth,” Michele said in a webcast on Tuesday.
In these strange and bizarre pandemic times, Michele is looking at the bond market through a very different lens than he would during normal times. “Bond yields are everything central banks want them to be,” he said. JP Morgan also expects there to be a fiscal stimulus package some time in the next four months.
“They are focused on insuring there is a recovery,” he continued. That’s why Michele views the bond market not as a set of yields but as the cost of funding an economic rebound.
There is no precedent in modern economic history for the current downturn that the global business cycle is currently facing. But the financial crisis of 2008 provides something of a recent mirror for the sake of comparison, even if the circumstances were quite different.
Here Michele finds a series of favorable contrasts. As sharp as the downturn was in March and April of this year, the current recession is largely devoid of the systemic problems associated with the subprime loans that brought the global economy to its knees in 2008.
Michele doubts the default rates in the junk bond market will reach the levels they did during the financial crisis. In that recession, bond defaults rose to 11% in the U.S. and 8% in Europe.
This time, the policy response has been far more dramatic than the TARP legislation, which simply injected capital into banks’ balance sheets, where it sat for years. When one tallies up the total amount of global fiscal stimulus and central bank balance sheet expansion, Michele estimates it is about $18 trillion.
Central banks have indicated they would like to see inflation run at a 2.5% rate “for an extended period of time.” How long is that? After the financial crisis, the Fed kept rates near zero for seven years.
Distortions caused by low rates can induce dubious behavior. Michele said he could see U.S. corporate debt, which currently stands at 48% of GDP, rise to 60%.
“Debt is really cheap to carry,” he observed. “But how much leverage does a company really wish to carry?”
Another positive factor is that downgrades from ratings agencies don’t appear to be that prevalent despite warnings from some quarters of shaky finances in a variety of industries, like energy and retailing. The agencies have “decided to give companies 18 to 24 months to get their balance sheets in shape.”
In contrast to widespread predictions of a wave of corporate bond defaults, Michele maintained that “99% of corporate borrowers should be fine.” Certain industries that have been partially shut down or capacity-constrained by the pandemic—like retail, travel, hospitality and real estate—are obviously being affected.
But Michele noted there is a lot of money sitting in distressed debt funds “waiting to step in and restructure” troubled business concerns.