State Street Global Advisors has been paring back its high yield bond exposure in favour of higher quality credit as recession risks rise.
“The odds of recession are higher today than they were two months ago,” said Lori Heinel, the firm’s global chief investment officer, at a recent media roundtable in Hong Kong.
“It’s a self-inflicted whiplash because we’re putting tariffs and other policies in place when things are going pretty well in the US economy.”
She noted how US unemployment remains close to 4% and economic growth continues at a faster pace than other developed economies.
“We’ve been going up more in quality in our credit book,” Heinel said, partly because she sees downside tail risks increasing.
“As recently as the end of the year, we were still overweight long duration and high yield,” she said.
“At the time, rates were a little bit higher so we wanted to be able to capitalise on what we saw as declining longer rates, and we thought that the risk of recession was very minimal, and so collecting that extra yield from high yield made sense.”
“We now have pretty much a flat duration position, and we’ve upgraded the credit quality, because we think the risks of recession have gone up and given that spreads are still relatively tight across the credit curve, including high yield.”
As such, the firm still sees value in fixed income and expects yields to follow the trajectory of policy rates as central banks globally continue cutting, but it is focusing on higher quality credit.
Repositioning equity exposure
Similarly, State Street has shifted from an being “wildly overweight” US equities for most of the past two years to now an overweight position in emerging market and European equities.
“We actually have a slight underweight to US equities right now,” Heinel said. “Towards the tail end of 2024 we had started to significantly pare back US equities. Part of that was valuations were stretched especially post-Trump election.”
State Street’s overweight in emerging markets is a result of attractive valuations as well as growing investor interest in China after its recent rally.
Heniel said: “Even though we’ve had a bit of a rally, it’s been more concentrated and we think there’s opportunity for broadening out there.”
She also noted that China’s economy isn’t necessarily tied to the fate of the US economy and its tariff policy. “China and Europe are much more tied together than China and the US,” she said.
“Obviously, there are ongoing threats from the US to increase tariffs still further, but we think it’s more a Europe and China story.”
“So long as Europe sentiment keeps improving and we start to see bigger demand in Europe, you could actually see that benefit China as well.”
European equities have rallied in recent months on the back of a potential resolution of the conflict in Ukraine and pledges by European leaders to boost defence spending.
