Whether you like it or not, the next recession is on its way. The big question is how long until it arrives. Most estimates range from 6-24 months, but most agree we are coming to the close of a very productive economic and market cycle. So what is the best way to prepare your and client’s portfolios for a downturn? The answer may be unconstrained bond funds, such as the Loomis Sayles Bond fund. Unconstrained bond funds, which can invest in any type of fixed income instrument in any geography, have done quite well this year compared to other areas of fixed income. Some funds are focusing much more on shorter term corporate credit, rather than rates, to greatly lower their interest rate risk.
FINSUM: Unconstrained bond funds seem like a good way to get some solid yields while also protecting against big losses. We think short-term Treasuries and investment grade are good choices, but are wary of longer-term sovereign bonds and junk bonds right now.
Investors, be worried about the Fed, and not for the reasons you think. While all the market’s focus has been on how quickly the Fed will raise rates, what could really cause problems is the Fed’s unwinding of its balance sheet. According to the Indian central bank, this unwinding is sucking Dollars out of the system and causing a Dollar liquidity squeeze. According to Urjit Patel, the governor of India’s central bank, this Dollar-squeeze means “a crisis in the rest of the dollar bond markets is inevitable”, with a growing “possibility . . . a ‘sudden stop’ for the global economic recovery”.
FINSUM: It sounds like emerging markets are going to have increasing trouble issuing Dollar bonds, which could definitely throw a wrench into the recovery. Maybe this is how the Fed sparks a global recession and not just an American one.
In an unusually blunt, but refreshing statement, Morgan Stanley put out a statement today calling George Soros’ warning of a financial crisis “ridiculous”. Morgan Stanley CEO James Gorman said while some of Soros’ concerns are warranted, others are not. For instance, Gorman said about Soros’ view of the EU that “I don’t think we are facing an existential threat at all”.
FINSUM: Gorman doesn’t know much about Europe if he does not think it is facing an existential crisis. It very well may not break up (we do not think it will), but it is certainly facing a reckoning about its own meaning and the value of being a member.
If you are not worried about markets and the global economy at the moment you should be. At least according to legend George Soros. The hedge fund manager thinks that the world is headed for “another major financial crisis”, this time spear-headed by politics. Soros believes the epicenter of the crisis will be the EU. “The EU is in an existential crisis. Everything that could go wrong has gone wrong”, said Soros, continuing that “it needs to reinvent itself”. Soros believes the problems in Europe have three facets: “the refugee crisis, territorial disintegration exemplified by Brexit and an austerity policy, prompted by the financial crisis”.
FINSUM: We sort of feel like we are in a time warp that loops back to the summers of 2011 and 2012. We do not believe the whole EU project, and the Euro will fall apart now.
Over the last few weeks the US stock market had looked strong. Stocks had shrugged off a number of geopolitical disturbances with relative ease. However, suddenly, a lot of macro signs are looking poor. The combination of European political turmoil, weaker growth, and a sudden drop in US bond yields, are all coming together in a package that shows things are not as rosy as they might have seemed a few weeks ago. While European sovereign spreads are widening to the largest since 2013, US Treasury yields are plunging and are now well below 2.9%.
FINSUM: This might be the start of a very rough summer for markets, and how fitting that it all began on Memorial day. While some might say “It’s just Italy”, Europe has proved enough to scuttle global markets in the past (see the summers of 2011 and 2012).
We might have just reached an inflection point in the market-economy mechanism. For the first time since 2008, short-term Treasury yields have just reached the same level as equity dividend yields. It is not even the two-year Treasury we are talking about, but rather the three-month, whose yield is now about 1.9%, the same as equities’. The convergence of a number of different yield rates is a strong warning sign of a pending recession. JP Morgan comments that “What has been surprising this year has been the degree to which cross-asset performance has behaved as if the late cycle had already arrived, despite little material change in the growth outlook”.
FINSUM: This is an important indicator. Both bond and stock investors are moving ahead of the economy itself, but their actions seem likely to create the reality they fear.