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August 2018 Investment Monthly

Corporate bond valuations improve
01 August 2018
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    Key takeaways

    • We move from underweight to neutral on US investment-grade (IG) and high-yield (HY) corporate bonds, resulting in a move from underweight to neutral for global IG and HY corporate bonds. We also move from underweight to neutral on US dollar (USD) emerging-market (EM) debt
    • Global equity markets rose in July, as upbeat corporate earnings results outweighed lingering global trade concerns
    • Amid strong economic data and despite rising trade tensions, Federal Reserve (Fed) Chair Powell testified that interest rates would keep gradually rising, “for now”
    • Recent eurozone activity indicators suggest growth has stabilised, following a weakening in Q1. The European Central Bank (ECB) remains on course to terminate its net bond-buying programme by the end of the year
    • In China, monetary easing, a slower pace of regulatory tightening and more funding for local government projects should help contain the risk of a sharp growth slowdown
    • The Bank of Japan downgraded its inflation forecasts for the next three years and reiterated monetary policy will remain very accommodative “for an extended period of time”

    A stronger investment case for corporate bonds

    Global economic growth slowed at the start of 2018, but has since stabilised at a good pace. Meanwhile, corporate fundamentals remain solid and default rates low. Yet recently, we think corporate bonds have become increasingly attractive on a valuation basis, especially in the US. Therefore, we move from underweight to neutral on US investment-grade (IG) and high-yield (HY) corporate bonds, resulting in an upgrade to our stance on global IG and HY corporate bonds from underweight to neutral. We are also more positive on European equivalents, although we remain underweight here as the improvement in valuations has not been as significant. Elsewhere, the recent sell-off in EM assets has improved valuations for USD-denominated EM debt, and we also upgrade our view to neutral from underweight.

    Our previous preference was to be invested in global equities and US Treasuries as a way to mimic the payoff from corporate bonds. We counterbalance this month’s view changes by moving away from this stance. Nevertheless, global equities remain a superior way to benefit from the robust global environment, and increased volatility presents buying opportunities, in our view. Meanwhile, we think US Treasuries are still relatively attractive versus other DM government-bond markets, especially for two-year notes, although higher US inflation is a key risk for this asset class.