Ready for a Bond Rally by the end of the year?

During November, the main financial markets were driven by Brexit, the trade war between the US and China, the mid-term elections, the FOMC, the defeat of Ms Merkel’s party in local elections and the beginning of social troubles in France. The month began with positive employment data from the US, with a surprising rise in average hourly earnings. In Europe, the fears of slowdown increased after the release of the German growth figures and as a result, government bonds rallied.

Monthly Fund Commentary
21 Dec 2018

During November, the main financial markets were driven by Brexit, the trade war between the US and China, the mid-term elections, the FOMC, the defeat of Ms Merkel’s party in local elections and the beginning of social troubles in France. The month began with positive employment data from the US, with a surprising rise in average hourly earnings. In Europe, the fears of slowdown increased after the release of the German growth figures and as a result, government bonds rallied.

Strategic Euro Bond Fund
Strategic Global Bond Fund
Strategic Quality Emerging Bond Fund

The three bond funds were closed on 14th December 2018 and replaced by a new Fund called Strategic Bond Opportunities Fund. As such, the Investment Adviser spent November preparing for these events. The Strategic Bond Opportunities Fund’s strategy will be the “best of” the three former Funds, the core portfolio being the former Strategic Global Bond Fund. In addition, select Emerging Market bonds (40% max) will be included within the portfolio, a number of which were previously held by the Strategic Quality Emerging Bond Fund. Further, the Fund also has the flexibility to hold exposure to EUR denominated bonds (20% max, hedged to USD).

Outlook

The Investment Adviser’s outlook is focused on two major topics, inflation and the Central Banks’ behavior. The risk that inflation remains subdued and the flattening of the US yield curve, combined with other topics such as the risk of an escalation of the trade war, suggests that recession fears will rapidly become a major concern. In addition, after the recent correction in emerging markets and the European periphery, the team is still convinced that high quality bonds, considered as safe havens, will attract more investors in the coming months.

In the US, the Investment Adviser believes that long U S Treasuries are still attractive, considering that they could be a top performing asset class in 2019. An inverted curve slope has not been ruled out in early 2019, after the Fed rate hike on 19th December. The Fed may be making a mistake by pursuing its monetary policy normalisation, the market not having the capacity to absorb any additional rate hikes. The Investment Adviser believes that the best strategy today is to keep investing in short term corporate bonds yielding around 3.5%, combined with 30y US Treasuries.

In Europe, the Investment Adviser believes that the Bund will match the US Treasuries behavior and will perform well in the case of any resurgence of tension on the periphery, in Italy in particular, or in France. A QE2 is possible in the Eurozone before the end of 2019.

Within Emerging Markets, the Investment Adviser continues to closely monitor the behavior of spreads (both governments and corporates) and the increasing volatility due to global risk aversion.

In conclusion, the Investment Adviser still believes that the best performing asset class is a mix of short term Investment Grade corporates and long-dated US Treasuries. The Emerging markets are likely to remain volatile during the coming months but if either trade or rate concerns ease, current levels offer an attractive opportunity to invest in very high-quality EM markets. Bonds denominated in euro and hedged in US dollar are also becoming an attractive investment opportunity.

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 11/12/18 and are based on internal research and modeling.