Bonds: the lender pays the borrower


The bond Market is bracing itself for darker times

Navigating current markets is no easy task. Risks are piling up on many fronts, in particular, trade tensions, Brexit, Iran, elevated global debt levels and the economic slowdown. Fears of recession are rising and the question is not if but when it will come. As bond yields are stubbornly heading lower, the bond market is bracing itself for darker times.


Central banks in action

The markets are putting a lot of faith in central bankers. Will the latter extend the economic expansion or just soften the slowdown? The question is open. What is certain is that central bankers are ready to act to boost growth and inflation. The Fed has ended its tightening cycle and cuts rates for the first time since 2008. The ECB has just followed suit and start repurchasing bonds. Other central banks in the world are moving towards a more flexible monetary policy.


Historically low or even negative returns

Impact of monetary policy is noticeable. Many bond yields have fallen to all-time lows and are now in negative territory for many European countries. Some European corporate bonds also yield below zero, even some risky (i.e, high yield) ones! In other words, it has become a luxury to own bonds and investors accept that they will make a loss if they hold certain bonds to maturity. So the lender pays the borrower. 


Over-optimistic equity markets

It is too early to abandon our short-term negative view on stock markets. Economic indicators have not yet stabilised. On the contrary, the overall industrial PMI business survey shrank to below 50, a level that points to a contraction in economic activity. The deterioration in trade relations between the United States and China is eroding confidence. Corporate profits, which are highly correlated to PMIs, are subject to downward revision . We believe earnings estimates for 2020 are too optimistic, and downward revisions are likely to dampen stock markets. Seasonality is not very favourable in September/October. There are however several factors limiting the downside risk, so we maintain our neutral view over the medium term.


There are still pockets of opportunities in the markets

Investors face the challenge of incurring risks while earning negative returns. Fortunately, alternatives exist and pockets of opportunities with low to moderate risk are still present in the markets.