Go High Yield for Bond Returns in 2017, says Schroders

Ditch US Treasuries in favour of high yield and emerging market bonds, says Schroder's Wesley Sparks - as rising inflation will put pressure on yields

Emma Wall 4 January, 2017 | 12:39AM
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All this week, Morningstar.co.uk will be bringing you a Guide to Investment Ideas for 2017; stock picks, market reactions and political forecasts from the investment professionals.

In the weeks following Donald Trump’s election win the S&P 500 rallied by the same amount as US Treasuries sold off by; investor confidence was up, and risky assets benefited. Then followed the much expected interest rate rise by the Federal Reserve, and the 10 year Treasury yield climbed higher – from 1.83% the day before the election, to 2.6% by mid-December. It currently sits at 2.45%.

Thanks to Trump’s inflationary policy proposals, the pressure is on for the Fed to raise rates further in 2017, with the Federal Open Market Committee indicating they will raise rates three more times this year. It comes as no surprise therefore, to hear that Wesley Sparks, head of US Credit Strategies for Schroders, is dumping US government bonds in 2017 in favour of high yield bonds.

“High yield remains one of the most attractive points of the market,” he explained. “This could change if the investors become risk averse, but we don’t think that will happen.”

Sparks, manager of the Schroder ISF Global High Yield fund, warned that much of Trump’s presidential stance is still unknown; while Hillary Clinton laid out clear policies in her campaign, Trump’s were “reduced to substanceless tweets.”

His plans to reduce the corporate tax rate to 15% and reduce personal taxes and increase spending including infrastructure development will be beneficial to markets and the economy, but there are concerns about his attitude towards trade, immigration and the healthcare sector.

There is even the potential for President Trump to cause recession and a market crash, warned Sparks – his elimination of tax incentives could encourage businesses to issue debt rather than equity, the government deficit is likely to rise with his spending plans and trade wars could bring about a 1930s-like depression. But these issues will emerge from 2018 onwards, if at all, Sparks explains.

Are Markets Too Positive?

“We are concerned that growth and stimulus will disappoint in mid-2017,” says Sparks. “The Fed is predicting two or more rate hikes this year, but we are cautious that expectations are too positive.”

However, he does concede that monetary policy is moving in one direction and that inflationary pressures are rising. As a result, he is adding to his high yield bond exposure, holding investment grade corporates and is poised to add to emerging market debt. Sparks is selling US Treasuries and shorting European government debt.

“We have recently added metals, mining and energy exposure to the portfolio,” he said. “Fundamentally the sector remains challenged but there were some fallen angels we picked up cheap.

“The positive swing following Trump’s election will continue for some time, which is good for equities, and bad for Treasuries – and positive for high yield bonds. When we do start to get softer economic data some time into the Trump presidency, then we will see the real market impact.”

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Emma Wall  is former Senior International Editor for Morningstar

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