Bonds driven by risk aversion in October

BY ERIC VANRAES

In October, the main financial markets were driven by risk aversion. As IMF president Ms Lagarde put it: “risks are starting to materialize”. During the month there were many sources of concern such as global growth, the ongoing trade war, the economic slowdown in China, the fall of equity markets, the collapse of emerging market currencies, Italy, Brexit, elections in Brazil and Germany, Iran and the murder of Mr. Khashoggi.

In the US, the month started with the release of good economic figures, with the unemployment rate having declined to a record low of 3.7% and the average hourly earnings having increased by +2.8% YoY. Following his concerns about rising interest rates which could lead to an economic slowdown, Mr. Trump broke yet another taboo, criticising the Fed’s behaviour and questioning its independence. As an example, the 30y mortgage rates increased from 4.5% to 5.125% in one month, indicating a rising interest rate environment.

At the end of the month, the US markets started to decline substantially, with the S&P500 breaking its 150 day moving average (2’777) and its latest 61.8 Fibonacci retracement (2’688). On 29th October, the index declined to 2’603 points, leading to a rally of the US Treasury market, with the 10y and 30y yields reaching 3.08% and 3.33% respectively.

In Europe, the level of uncertainty was still high in absence of a Brexit deal, the defeat of Angela Merkel’s party in regional elections (Bavaria but more importantly Hesse) and the threat of a new crisis in Italy due to the new budget deficit policy which is not compatible with the rules of the European Union. As a result, Italy’s sovereign rating was downgraded from Baa2 to Baa3 (stable) by Moody’s, while Standard & Poor’s confirmed their BBB rating, at the same time however changing the outlook from stable to negative. The markets perceived these actions as good news, with Italy’s rating currently being far from downgraded to junk. In addition, during his ECB press conference, Mr Draghi adopted a firm but considerate tone towards his compatriots.

With regards to emerging markets, Chinese GDP growth was weak in September (+6.5%), constituting the smallest YoY increase since 2009. In Brazil, Mr. Bolsonaro was elected president, with the markets growing impatient to hear about the new economic policies implemented by his economic adviser, Paulo Guedes.

STRATEGIC EURO BOND FUND

During the month, the Investment Adviser sold the remaining stakes in the French EDF hybrid bond and RCI 2021, with the modified duration remaining around 3.5. In terms of portfolio diversification, the Fund held 28 issues from 28 issuers. STRATEGIC GLOBAL BOND FUND This month, the Investment Adviser increased exposure to 30yr Treasuries and sold the remaining stakes in Roche FRN 2019 and Tencent 2020. The modified duration was increased to 5.14. In terms of portfolio diversification, the Fund held 25 issues from 22 different issuers.

 STRATEGIC QUALITY EMERGING BOND FUND

During the month, the Fund’s modified duration was maintained around 4.5. In terms of portfolio diversification, the Fund held 31 issues from 31 issuers.

OUTLOOK

The Investment Adviser’s outlook is tied to two major topics, inflation and the positions adopted by Central Banks. Inflation risk remains subdued and the US yield curve continues to flatten. In combination with other considerations such as an escalation of trade war risk, these factors suggest that recession fears will rapidly become a source of major concern. In addition, after the recent correction within emerging markets and the European periphery, the team are still convinced that high quality bonds, considered as safe havens, will attract more investors during the coming months.

In the US market, the Investment Adviser believes that long US Treasuries are still attractive, considering that they could be a top performing asset class in 2019. After the Fed’s potential rate hike on 19th December, an inversion of the curve’s slope is not excluded at the end of the year or in early 2019. According to the team, the Fed may be making a mistake by pursuing the normalisation of its monetary policy, with the markets not having the capacity to absorb additional rate hikes.

The Investment Adviser believes that the best strategy currently is to keep investing in short term corporate bonds yielding around 3.5% combined with 30y US Treasuries.

In Europe, the team thinks that the Bund will match the behaviour of US Treasuries and, in addition, will perform well in case of any resurging tension in the periphery, particularly in Italy. 

In emerging markets, the Investment Adviser will continue to closely monitor the behaviour of spreads (both governments and corporates) and increasing volatility due to global risk aversion. With an increased performance dispersion, the team thinks that high-quality emerging debt still offers a very attractive riskreward profile, in particular after the recent spread widening, and continues to benefit from both attractive valuation and encouraging technical factors. In the short term, the team will remain very cautious, with the recent purchase of 2y US Treasury likely to contribute to a better relative performance of low beta investments.

In conclusion, the Investment Adviser still believes that the best performing asset class is a mix of short term Investment Grade corporates and long-dated US Treasuries. In the team’s opinion, emerging markets will probably stay volatile during the coming months. This said, should either trade or rate concerns ease, current levels offer an attractive opportunity to invest in very highquality EM markets according to the Investment Adviser.

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The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 08/11/18 and are based on internal research and modelling.​

Further insights

November 2018

October lived up to its reputation being a difficult month

October once again lived up to its reputation for being a complicated month in the stock market, with the Fund loosing -7.39%* during the month. More globally, the S&P declined on 16 out of 23 days, leading to a 6.9% loss in the US, shedding nearly $5Tr worth of collective market cap.
November 2018

October turmoil

As stated in the previous commentary, the Investment Adviser is still positive regarding equities’ short term potential to regain ground, but is cognizant that this scenario requires some positive developments on the international front and the economic backdrop to remain healthy.