FIXED INCOME ASSET ALLOCATION INSIGHTS - AMID CAUTION, EMERGING MARKETS OFFER VALUE - PINEBRIDGE INVESTMENTS
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Fixed Income Asset
Allocation Insights
Amid Caution, Emerging Markets 21 May
2020
Offer Value
Robert Vanden Assem, CFA, Head of Investment Grade Fixed Income and Chairman About This Report
of Fixed Income Asset Allocation Team Fixed Income Asset Allocation
Continuing gains in investor confidence drove credit spreads tighter for most fixed Insights is a monthly publication
income asset classes over the first few weeks of May, albeit at a slower pace than that brings together the cross-
in April. Fueling the optimism were consistent monetary and fiscal support and sector fixed income views of
anticipation of an imminent reopening of economies as most developed market PineBridge Investments. Our global
countries move past peak infection. But risk concerns remain elevated amid record team of investment professionals
unemployment, uncertainty over the timing of an economic rebound, deteriorating convenes in a live forum to evaluate,
US-China relations, and political risks emanating from the US presidential election, debate, and establish top-down
Brexit, and a fracturing of the European Union over reconstruction funds. Against guidance for the fixed income
this backdrop, we believe a cautious approach remains prudent, although we universe. Using our independent
continue to look for opportunities to add risk at attractive levels. We think such analysis and research, organized by
opportunities present themselves in emerging market (EM) debt, where valuations our fundamentals, valuations, and
remain very attractive, especially when considering the resilient fundamental picture technicals framework, we take the
and technicals that have improved on a reversal of outflows and the reopening of the pulse of each segment of the global
new-issue market. As a result, we have increased our allocation to EM debt by 5%, fixed income market.
using proceeds from the securitized products allocation.
Target Portfolio Allocations
(as of 21 May 2020)
US Macro View
Leveraged Finance
Markus Schomer, CFA, Chief Economist 35%
Becoming somewhat less bearish Investment Grade Credit
Our US macro bear case probability now stands at 50% after moderately reducing 20%
its overweight, and our bull and central case probabilities are at 5% and 45%,
respectively. With the worst of the health crisis seemingly over and most states Securitized Products
gradually reopening, stabilization should come in May and a rebound in June. 25%
Expect a steep second-quarter contraction followed by third-quarter growth, but real
Emerging Markets
GDP won’t return to pre-Covid levels until the first quarter of 2022.
20%
Market movers
Non-US-Dollar Currency
More stimulus. Bears fret that consumers will be too fearful to drive demand once
0%
supply constraints are lifted. While this may be true initially, we expect demand to
return in the third quarter (barring a second infection wave) — although not to levels
0% 10% 20% 30% 40% 50% 60% 70%
seen in the fourth quarter of 2019, given higher unemployment.
Current Target Allocation
Fiscal cliff. With more than $3 trillion in fiscal stimulus and perhaps $1 trillion in
Tactical Band
automatic stabilizers, the US is building a sizable income bridge for the economy.
More is needed to avoid a fiscal cliff in 2021, but the next stimulus package has run For illustrative purposes only. Any
into partisan political crossfire. opinions, projections, forecasts, and
forward looking statements presented
Second waves (of stimulus). After creating a wave of facilities to support financial are valid only as of the date indicated
and are subject to change. We are not
markets, the Federal Reserve will have to sharply increase secondary market soliciting or recommending any action
purchases or directly finance part of the deficit to meet the coming wave of Treasury based on this material. There can be no
issuance, which could outstrip the market’s ability to absorb. assurance that the above allocations
will be in any account at the time this
information is presented. This material
must be read in conjunction with the
Disclosure Statement.Leveraged Finance Technicals
Year-to-date IG issuance was $750 billion, or 87% higher year
John Yovanovic, CFA, Head of High Yield Portfolio Management over year. Despite massive new issuance, technicals are strong
due to Fed buying, many nontraditional buyers, and renewed
Fundamentals foreign demand.
Issuers report decent earnings but are providing no forward
guidance. Fed programs have successfully opened liquidity
avenues for issuers, likely ensuring lower-than-estimated
defaults. Energy and retail remain decoupled from the
Non-US-Dollar Investment Grade Credit
Roberto Coronado, Portfolio Manager, Non-US Dollar Investment
overall market. More downgrades have resulted in single-
Grade Credit
Bs now accounting for a record percentage of the loan
market. Collateralized loan obligations (CLOs) are bracing for Fundamentals
downgrades. Negative. It’s still difficult to know how badly economies and
corporates will be affected by the lockdowns, and similarly tough
Valuations to predict the effectiveness of fiscal support. The only certainty
Option-adjusted spreads (OAS) on the Bloomberg Barclays is that the entire world will have a very tough first half of the year.
US Corporate High Yield Index peaked at 1,100 on 23 March
and are now 691 (625 ex energy) as of 20 May, implying a 6.1% Valuations
forward default rate, which is near our 7% estimate for 2020. Positive, but less so. Credit spreads, somewhat stable after the
Range-bound valuations are now fair in a recession scenario and volatility of March and April, still offer value, with many sectors
somewhat attractive in a 2021 recovery scenario. still pricing a very negative outcome.
Technicals Technicals
Despite spread volatility, high yield (HY) has seen $27.6 billion Positive. The European Central Bank’s additional support
in steady inflows over the past seven weeks. Trading is back through its Pandemic Emergency Purchase Program has been
to being relatively two-sided in the work-from-home environment, material and is expected to increase. In addition, we have seen
but transaction costs remain elevated. Primary issuance inflows into the asset class so far this month, although offset by
has returned, with $21.8 billion coming to market in May month- large primary supply.
to-date.
Investment Grade Credit Allocation Decision
Leveraged Finance Allocation Decision We maintain our allocation of 20%. The Fed buying program
We maintain our allocation of 35%. Valuations are fair has provided a liquidity backstop and made it easier for
near term, but inexpensive over a six- to 12-month horizon. lower-rated credits to access the market. We look to replace
We continue to seek opportunities to add risk, but remain potentially troubled issues with more resilient credits and
moderately under-risked against the broad index. continue to take advantage of attractive primary issuance.
Investment Grade Credit Emerging Markets
US Dollar Investment Grade Credit Sovereigns
Dana Burns, Portfolio Manager, Anders Faergemann, Portfolio Manager,
US Dollar Investment Grade Fixed Income Emerging Markets Fixed Income
Fundamentals Fundamentals
As Covid-19-related disruptions negatively affect the global Over the next 12 months, we believe growth in emerging markets
economy, investment grade (IG) fundamentals remain will bounce back in tandem with developed markets as monetary
challenged. Leverage and downgrades within IG will likely and fiscal accommodation provide support. We are tracking
increase. Nevertheless, should a significant second wave of high-frequency indicators to assess which countries can do
Covid-19 be avoided, we expect fundamentals to gradually better post lockdowns based on their trade dynamics.
improve in the second half.
Valuations
Valuations Valuations have improved, reflecting spread tightening since
Bloomberg Barclays US Credit Index spreads have tightened the peak, with the Emerging Markets Broad Index (EMBI) Global
inside of 200 basis points (bps), which, while historically cheap, Diversified trading at +554 bps, IG at +280, and HY at +965.
may appropriately price near-term risks. Concessions on new
deals have shrunk. Select credits continue to offer value.
PineBridge Investments Fixed Income Asset Allocation Insights | 2There is still plenty of value, both in absolute- and relative- Emerging Markets Allocation Decision
value terms, taking into account our benign 12-month outlook We increased our allocation to 20% from 15%. Although
for fundamentals. We think the HY space offers more value, headwinds remain, we see buying opportunities in the market
particularly across single-Bs. as decent stimulus, relatively strong fundamentals, a better
technical environment, and valuations at attractive levels are
Technicals
supportive of the asset class.
Technicals have slightly improved, as outflows in US dollar debt
are reversing and the new-issue market – still dominated by IG –
has reopened, with many heavily oversubscribed deals coming at
modest new-issue premiums. Securitized Products
Andrew Budres, Portfolio Manager, Securitized Products
Fundamentals
Corporates Policy clarity on forbearance will be a tailwind for mortgage-
Steven Cook, Co-Head of Emerging Markets Fixed Income
backed securities (MBS) over the next 12 months. After that,
Fundamentals uncertainty reigns over the percentage of borrowers able to
Despite short-term weakness over the impact of Covid-19 in the resume making their mortgage payments.
second and third quarters, we see resilience in fundamentals
over the longer term. Current downgrades, largely on the back Valuations
of sovereign rating actions, are generally not dire; of our 261 IG Spreads have additional room to tighten, but don’t look for a
credits, only 13 are expected to become fallen angels. repeat of QE3 spread-tightening levels.
Valuations Technicals
Corporate Emerging Markets Bond Index (CEMBI) Broad The Fed’s pace of MBS buying has been “steeper” than QE3, but
Diversified spreads finished March 60 bps tighter, led by IG. After we see the Fed scaling back when it feels the market is operating
a torrid March, some normality has returned. EM corporates normally.
have retraced about one third of the wides hit in March and are
now cheap based on our positive fundamental view on both a Securitized Products Allocation Decision
relative and absolute basis. We reduced our allocation to 25% from 30%. All else equal,
MBS spreads should continue to grind in slowly given Fed
Technicals
intervention. The ruling about forbearance resolutions was
The reopening of the previously strong IG primary market, with
welcomed by the market, but forbearance could be over-
new issues getting done with minimal premiums (given books
utilized by borrowers if the economy seriously worsens.
are over five-times covered, on average), is a sign investors have
cash to put to work.
Our Recession Case Scenario Probability Slightly Increased While Our High Growth Case Scenario Probability
Decreased During the Month
Fixed Income Scenario Probabilities – Next 12 Months (as of 21 May 2020)
Increase Decrease Unchanged
Scenario Probabilities
Avg.
US GDP USD Scenario USD Securitized Leveraged Non-
Growth Inflation Basket Probability Inv. Grade Products Finance EMD USD IG
Recession; Deflation Breaks 5% band
< 1% < 1% 41% 40% 30% 50% 45% 40%
on the downside
Scenario
Central Case Maintains
1-3% 1-3% 56% 60% 70% 40% 50% 60%
- 5% to +5% band
High Growth; Inflation Breaks 5%
> 3% > 3% 3% 0% 0% 10% 5% 0%
band on the upside
Source: PineBridge Investments. For illustrative purposes only. Any opinions, projections, forecasts and forward-looking statements are based on certain
assumptions (which may differ materially from actual events and conditions) and are valid only as of the date presented and are subject to change.
PineBridge Investments Fixed Income Asset Allocation Insights | 3Non-US-Dollar Currency Dmitri Savin, Portfolio Manager, Portfolio and Risk Strategist, Emerging Markets Fixed Income Fundamentals While the US dollar currently appears favorably positioned against the euro and the Japanese yen, we find no reason to alter our neutral US dollar outlook or change our 12-month euro/US dollar forecast range of 1.08-1.12. Valuations Despite near-term uncertainty, G3 currencies have been trading in fairly narrow ranges. The Japanese yen is stronger than expected, and EM currencies are largely undervalued against the US dollar, with the Mexican peso, Turkish lira, and Colombian peso providing the best risk-reward, in our view. Technicals Data suggest all reserve currencies are notionally net long the US dollar, while the cyclical G10 dollar bloc (the Australian, New Zealand, and Canadian dollars) are all short, aggregating to US dollar net shorts of -$10.5 billion – levels last seen in May 2018. Non-US-Dollar Currency Allocation Decision We maintain our 0% non-dollar allocation. Currency volatility appears to have peaked for now, suggesting we could see more months of range-bound currencies. A shift toward a strong US dollar policy by the Trump Administration, combined with growing political uncertainty in Europe, could underpin the US dollar versus the euro. PineBridge Investments Fixed Income Asset Allocation Insights | 4
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