Investor Update: Fixed Income Market Commentary

Thought you might be interested in my comments below from an email exchange re the US bond market.  FYI…

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I got out of bonds a long time ago. 

The way I manage money is to view the space in my portfolio as cherished territory that each asset has to be worthy of inhabiting.  And if at any point I find a better risk/reward asset, then it should replace something in the portfolio that is less worthy. 

With that in mind, the fixed income space has not ranked high on my list of risk/reward payoffs for a while now.  Not that I'm so bullish on global growth, in fact, I'm actually still quite leery of prognosticators who argue for robust growth returning in '14, but I do think that there's enough global growth to expect rates to start heading higher in coming quarters, if not, in the next year of two.  With rates as low as they are, it's hard to argue that there's ample upside to owning bonds, relative to the downside especially should Yellen turn out to see reasons to start tapering sooner than later. 

Also, I think there's reason to expect, in general, for emerging market local bond markets to continue to develop and to represent better alternatives for global investors, of course this being over time and only following future events like the kind of 'shock' that we witnessed last summer with the Tapering induced EM selloff.  Over time, I do think that more and more foreign capital will choose the likes of Chinese Yuan assets over USD, at least in increasing percentages of holdings.  Did you see the recent TIC data?  It showed that official foreign flows into US bonds and notes declined pretty meaningfully, and that was the fourth month in a row. (by contrast, private foreign investor flows into the US went up, some into notes and bonds, lots into equities).  I do fear that in coming years, USD fixed income will have increasing amounts of competition that will attract capital.

So I remain uninspired by US fixed income, and think of a shorter term tactical range as 2.5-2.9% on US 10s.  I’m ambivalent for now on credit spreads since I think the credit worthiness of even high-yield assets is remarkably good, so spread widening, while it is likely to happen as capital flows leave fixed income,  may not be in the offing anytime soon.

As you know, I've remained cautiously bullish on equities.  I'm mostly holding US names, many of which have large %ages of their businesses in EM countries, so that's my 'indirect' play on EM (safer, more transparent and visible). I've been adding selectively to names when the market trashes a stock on a small miss in earnings, as long as I think the lower price represents good valuation.

So there you have it.  Turning my back on bonds!  Embracing equities cautiously.  Loving cash, despite the inflation erosion.  And watching the following as key potential catalysts for a change in view:

• Christmas shopping season and the behavior of US consumers. 
• January’s US debt ceiling and budget redux 
• China’s reform measures taking shape
• Europe’s ‘green shoots’ that have inspired hopes of the beginnings of a broad based economic recovery vs (see next note) 
• Europe’s ongoing challenge of fiscal austerity, suffocating debt loads and painfully high unemployment
• Middle East usual suspects of geopolitical tensions, especially Iran’s nuclear negotiations and Israel’s response.
• Japan’s Abenomics which has been given enormous early endorsement by markets and now faces “proving it”….or else.  
• Asia ex-Japan rising debt loads that could be explosive should we get another ‘tapering’ induced rout of EM currency, bonds and equity markets.

Will keep you posted.

Best,

Ed

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