Two top portfolio managers share their views.
For many investors, generating a high, sustainable income is challenging as global growth decelerates and central banks set policy rates higher. Traditional sources, such as bank deposits and bonds, may no longer help them meet their real spending needs. At the same time, if you focus singularly on the highest yielding securities, you could make yourself vulnerable to downside risks.
So what should you do now if you want to enhance yield? How should you be positioning your investment portfolios and building income streams? We asked two top portfolio managers about today’s challenges and their views on how investors might respond. Leon Goldfeld, a Managing Director on the J.P. Morgan Multi-Asset Solutions team spoke with Adrian Petreanu, who’s at the Ashmore Group, an investment firm that specializes in emerging markets.
Here is what they have to say:
Is a recession coming soon?
“The yield curve inversion is not a foolproof predictor of recession,” says Goldfeld. “J.P. Morgan looked at significant indicators such as unemployment claims, business confidence and ISM manufacturing data. Our conclusion: There’s currently about a 30 to 40% risk of recession risk—but recession is not the base case. We expect global growth led by United States to be around trend.”
“Usually,” Goldfeld added, “structural imbalances cause recession,” and, at this point, he does not see a lot of structural imbalance. Therefore, recession if there is one, is likely to be shallow. Politicians have little tolerance for social dislocation in a populist world. That is why he expects they would deal with any downturn very quickly. He also believes it does not pay to be structurally underexposed. Corrections are meant to be bought, because it is hard to see them last.
What impact will the U.S. v. China trade war have?
Tariffs raise prices, affecting business and consumer confidence. However, confidence can be buoyed by lower costs for funding created by Federal Reserve cuts to the U.S. interest rates. As a result, “Investors should be more defensive but not overly risk-averse,” Goldfeld says. J.P. Morgan’s Multi-Asset team has reduced equity exposure and added to its allocations to credit, short-term assets and cash.
“On the brighter side,” says Adrian Petreanu, “the trade war is creating investment opportunities in Asia’s high-yield credit markets, in particular China’s. The Chinese high-yield property names offer double-digit yields for a stable part of the market.” Facing headwinds from trade worries, Chinese investors turn to local consumption. Property in China has been the mainstay of value and is important to supporting consumer confidence. The Chinese government has been supporting consumer spending with monetary and fiscal stimulus. Petreanu says that he is confident that China can support the property sector for a significant period while a solution to the trade war is sought.
There are two significant drivers of demand for property in China over the longer term:
1) Wealth accumulation – There is a long tradition in China, and Asia in general, for families to invest their wealth in property and pass it on to the successive generations. With significant wealth creation in China and ongoing restrictions on taking capital out of the country, the affluent will keep investing in property.
2) Urbanization – As of the end of 2018, only 59% of China’s population lives in urban areas. That is relatively small when compared with an average urbanization rate of 80% for developed countries. If China is to reach developed markets urbanization levels over the next 20 years, it needs an increase of 20% in urban population—and that will translate to an increased demand for property in cities.
Where are portfolio managers expecting yield?
“J.P. Morgan will de-risk but won’t go to the extreme of 100% cash,” says Goldfeld. There are sources of income that are still attractive relative to cash. A multi-asset income strategy could potentially generate 4 to 5% when cash and bond yields are low.
J.P. Morgan sources yield from different geographies, sectors and across capital structure:
- Preferred equities at 5.8% yield is a fairly attractive opportunity.
- European equities yield about 4.7% currently.
- Hedged back to USD, European equities yield about 7.3%.
- European high yield in local currency yield about 3.3% but hedged back to USD, the asset class yields about 5.9%.
Petreanu suggests investing in countries with lower debt-to-GDP and higher growth in emerging markets. Growth is expected to pick up in emerging markets this year, while developed markets are expected to slow. Emerging markets risk also benefits from diversification over 70 different countries, which are all at different points in their economic cycles. Investors can choose the countries that fit the sort of risk profile that suits their needs. Growth differential between emerging markets and developed markets are highly correlated to capital flows. When differential narrows, capital leaves emerging market.
“From the start of 2019,” Petreanu says, “Ashmore has seen increased inflows of capital in favor of emerging markets as the growth differential narrows.”
But what about the emerging markets risks?
Emerging market investing is volatile and requires active management.
After the Crimea invasion in 2014, the U.S. government imposed sanctions on Russian issuers. Markets expected defaults to rise. Spreads widened 1,000 basis points. But Russia corporates did not default, having switched to local currency funding. Subsequently, spreads tightened 700 basis points.
In 2015, the oil price decline affected Venezuela and Ecuador with bonds selling off significantly, but in the subsequent 12 months the strategy generated 15–20% positive returns.
Similarly, markets overreacted to political uncertainty in Argentina over the 2019 summer months. The market is now pricing in high probability of default and therein lies opportunities. Volatility in August is typically higher than other months of the year because of seasonal lower liquidity, but come September, liquidity returns to normal and often the moves seen in August get reversed.
Emerging market high-yield credit spreads are wider today, compared to the highs seen in 2018, despite defaults remaining at historically low levels. Petreanu says he sees this as temporary mispricing and expects spreads to tighten significantly going into Q4. “This opens up an entry point for investors willing to allocate capital to emerging markets now,” he claims.
We can help
Speak with your J.P. Morgan team to see how these ideas and perspectives might inform the investment choices that suit your needs.
Provided for information only, not to be construed as investment recommendation. Investments involve risks, not all investment ideas are suitable for all investors and are not similar or comparable to deposits. Views and opinions are those of the speakers based to then prevailing market conditions and are subject to change from time to time. Estimates and forecasts may or may not come to pass. Diversification does not guarantee positive returns or eliminate risk of loss. Positive yield does not imply positive returns.