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Investment outlooks / Q3 2020

Fixed income

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The Federal Reserve has signaled that rates will be on hold for most of 2020. Unless something materially changes to the downside, we agree with this stance. As such, the recent widening of treasury yields provides an opportunity to obtain some yield for portfolios. The economy continues to perform well, and the consumer remains robust, so we do not see the prospect of a recession looming just yet. We expect a rangebound trading environment and look to play on the long side, targeting 1.9 to 2 per cent on the 10-year as an entry point to buy treasuries. Our scorecard analysis of the current conditions gives us 11 Buy indicators and six Sell indicators, leading to an overall Buy signal.

In credit, we see default rates contained and look at the attractiveness of the credit spread. While high yield flirted between fair value and rich in the last quarter, we note that spreads currently remain compressed to investment grade at historically low differentials. We do not expect much change in this range of value for high yield and were underweight US high yield going into 2020. With risk assets having caught a bid in late 2019, spreads have also compressed and our Z-scores indicate investment grade is also expensive. Overall our scorecard for credit indicates a Buy signal with a low confidence, so we look to maintain a Neutral stance to benchmark overall.

With the UK election having delivered some clarity on the political front, the focus now is not on when Brexit will happen, but the composition of the transition period and the trade deal negotiated during this period. While yields have widened, we view this as an opportunity to enjoy some carry. We expect further volatility around the transition negotiations and the Bank of England will not be looking to raise rates until certainty in this sphere is established. In addition, with the rest of the developed markets on an accommodative stance, we do not expect UK bonds to decouple from bonds of those markets.

We look to maintain our UK gilt holdings at neutral to benchmark despite valuations and will be looking for opportunities to move overweight. For yield enhancement, we look to substitute our gilts for holdings in strategic government sponsored entities such as Transport for London.

The sterling denominated investment grade bond market has traded at a discount since 2016 with the backdrop of Brexit risk. The composition of the UK sterling market available to investor visa clients is overweight in the financials and utilities sectors, both with large domestic revenue streams and set to benefit from the formation of a majority Conservative government.

With the risk of a Corbyn-led Labour government, with its pledges to nationalise companies such as British Telecom and the major utilities companies, gone, bonds in those companies have rallied. While there is still risk of supply chain disruption to corporates over the next 12 months, as the newly formed UK government negotiates trade agreements with the EU, we expect a return of lender confidence to the sterling capital markets to provide support for the asset class.

Equities

The Federal Reserve has signaled that rates will be on hold for most of 2020. Unless something materially changes to the downside, we agree with this stance. As such, the recent widening of treasury yields provides an opportunity to obtain some yield for portfolios. The economy continues to perform well, and the consumer remains robust, so we do not see the prospect of a recession looming just yet. We expect a rangebound trading environment and look to play on the long side, targeting 1.9 to 2 per cent on the 10-year as an entry point to buy treasuries. Our scorecard analysis of the current conditions gives us 11 Buy indicators and six Sell indicators, leading to an overall Buy signal.

In credit, we see default rates contained and look at the attractiveness of the credit spread. While high yield flirted between fair value and rich in the last quarter, we note that spreads currently remain compressed to investment grade at historically low differentials. We do not expect much change in this range of value for high yield and were underweight US high yield going into 2020. With risk assets having caught a bid in late 2019, spreads have also compressed and our Z-scores indicate investment grade is also expensive. Overall our scorecard for credit indicates a Buy signal with a low confidence, so we look to maintain a Neutral stance to benchmark overall.

Author
Dolfin
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