The varied performance of global bonds across different markets in today’s macro environment gives active managers scope to generate alpha from individual sectors and assets.
Investors also need to contend with different growth cycles across geographies. For example, the UK, the US and Europe face a mix of banking stress, persistent inflation and heightened geopolitical risk. By contrast, growth in Japan and China continues to tick upwards, although more slowly than previously forecasted.
As a result, PGIM Fixed Income has reduced its estimate of the probability of recession from 40% to 25%.
“Our concerns about the banking crisis and the debt ceiling have receded and labour markets continue to be strong, so underlying economic growth continues to be quite robust here, albeit at a slower pace,” said Gregory Peters, co-chief investment officer at PGIM Fixed Income.
Against the macro backdrop, the firm has seen positive excess returns over the last month or so by being short duration in the front end of the curve and adding duration tactically when appropriate.
Getting selective by sector
In terms of specific sectors, housing is now in good shape – being unlevered after learning its lessons about mortgage underwriting, ensuring loan-to-values are high.
“We’ve ridden the wave of house price appreciation and just as house prices started to fall, they’ve stabilised and are moving back up,” said Michael Collins, managing director and senior portfolio manager at PGIM Fixed Income. “This is a function of very limited supply, not only of new homes, but of existing homes and we still expect millennials to enter their home-buying years, which adds to the solid fundamentals we are seeing right now.”
The asset manager is also positive on the money centre banks, which have gained market share during the regional bank sell-off. “We went into the regional bank problem with an underweight position but have taken advantage of the sell-off and have been tactically adding to our holdings,” added Collins.
More broadly, PGIM Fixed Income favours the private sector versus the public sector. “The excess capacity and over-leveraging that we’ve seen in past cycles which caused the big drawdowns are not really in play today,” explained Collins.
Instead, the debt is concentrated in the public sector, in particular among the big sovereigns in developed and emerging markets. “We anticipate seeing cracks in emerging market sovereigns as these countries cannot service their debt by printing their own currency,” he added.
Ready for downgrades
PGIM Fixed Income is also constructive on the high yield (HY) market versus investment grade (IG) bonds.
This is based on the firm’s expectation of credit downgrades, where bank loan issuers and leveraged loan companies that have low B ratings are starting to get downgraded to CCC.
“That trend is going to continue,” said Peters, adding that the increase in rising stars, where HY names become IG, is over. “We are starting to see a handful of IG companies downgraded from single A to triple B or from high-triple B to mid-triple B, so it is beginning to happen. This isn’t a time to load up on IG corporate bonds or even on HY bonds because of the deterioration expected.”
With spreads widening likely, the firm has an underweight position in IG corporates with a small overweight in HY.