The Point

TIM HEXT: Inflation noise gets louder but real yields move markets

How to think about high-yield bonds right now

The jump in bond yields this year has been stark, particularly in the high-yield end of the market.

US double-B rated bonds, for example, yielded 3.2% at the start of the year and are now around 6%.

Is that enough to look at high-yield investments, given the risk-reward trade-off?

“Fixed income is, in our view, certainly much more investable today than it’s been for a while,” says Bill Bellamy, who heads up income strategies at Pendal’s US-based investment manager TSW.

“But we’re probably not totally done with this corrective phase and there is still room to go with yields. As they rise, there are going to be some very good opportunities.”

High-yield bonds can provide an income cushion not available with investment grade bonds, says Bill.

But investors need to analyse the underlying credits ultimately going into a portfolio – not just for safety but to unveil mis-priced assets, he says.

Labor won’t bring big change on the economic front

After the evolution of Coalition fiscal spending habits during Covid, our new Labor government won’t be a big change on the economic front, says Pendal’s Anna Hong.

“Australians will be largely unaffected, at least near term,” says Anna.

Labor will increase fiscal spending by net $7.4 billion in areas such as home equity schemes and electric car discounts.

“That will prop up demand without fixing supply issues, nudging inflation higher and making the RBA work harder to counter loose fiscal policy.” The budget will remain in deficit for the rest of the decade.

Labor may face difficulty generating planned revenue and savings. “Many items on their list such as multinational tax revenue are easy to promise but notoriously difficult to achieve. “Overall, it’s more of the same for the economy and budget. The difference will be in other changes many voters are focused on – climate policy, federal integrity and gender equity.“

The future of bonds (no they’re not disappearing)

Technology is changing our lives all the time. In financial markets it’s no different.

“The next decade will see an increased use of blockchain technology across all asset classes and finance,” says Pendal’s head of government bond strategies Tim Hext.

“This will increase efficiency. But it won’t make the underlying assets redundant.

“Crypto will have a role but it will not replace the Australian dollar. Bonds may become more digital but they will not disappear.

“The need to borrow and lend money is as old as time itself — and the need for efficiency in buying and selling loans packaged as bonds will also remain.

“Diversification remains an important investment concept. Add liquidity and credit quality and it means government bonds are not going anywhere.”

Tim Hext: Dust off the text books as stagflation threat looms

We can expect a lot more mentions of stagflation this year following fed Chair Powell’s acknowledgment last week that he would “do what it takes” to fight inflation.

Many of us wil be dusting off the textbooks, having not lived or at least invested through stagflation conditions, says Pendal’s Tim Hext.

“If taken at face value US rates may need to go far higher than the current 2% factored in by markets.

“Suffice to say it is bad news for most of us, seeing not only our investments but also our spending power go backwards.”

Inflation should pass 3% this year and could hit 5% on an annual basis, Tim says.

“But as long as wages don’t lock in with inflation shocks — creating the vicious circle we saw in the 1970s — supply will eventually return to commodity and goods markets.”

“It just might not be a 2022 — or even a 2023 — story.”

Be ready for a Russian default as sanctions bite

Few investors would take issue with global sanctions aimed at limiting the terrible human toll of Russia’s invasion of Ukraine.

It’s accepted that the financial implications will impact markets around the world. But what does it mean in terms of asset allocation?

“There is an increasing chance that Russia might default,” says Oliver Ge, a portfolio analyst with Pendal’s Income and Fixed Interest team.

“Russia has about $US640 billion of reserves of which $US400 billion is frozen in central banks around the world. On conservative estimates it costs about $US1 billion a day to run the war, so the impact to Russian coffers is material.

“The message to advisers is that if you were told at the start of the year that you’d get 5 to 7 per cent growth, that’s not going to play out in the current state of affairs.

“So, you should be very wary about holding growth assets and potentially think about some rotation to bonds. Bonds will keep paying,” he says.

“It shouldn’t be a massive rotation, but investors should be more mindful around the expectations of growth assets.”