BlackRock Commentary: Negative real yields underpin equities

Wei Li, Global Chief Investment Strategist and the BlackRock Investment Institute together with Ben Powell, Chief Investment Strategist for APAC, Yu Song, Chief China Economist and Vivek Paul, Senior Portfolio Strategist, all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Market volatility is on the rise, as worries about new virus strains have been exacerbated by stretched positioning and light summer trading. Recent swings in market sentiment reflect the unusually wide range of potential outcomes beyond the current economic restart, in our view. Market overreactions may create opportunities to readjust portfolios to a pro-risk stance as we maintain high conviction in our new nominal investment theme that implies low real yields.

Article Image - Negative real yields underpin equities

Market sentiment has been swinging between extremes: One week the concern is runaway inflation; the next it’s the prospect of a deflationary spiral. Most recently, bond markets appear to have ignored the latest strong U.S. employment and inflation data, and are focusing more on virus fears. Real, or inflation-adjusted, yields have dropped back toward historic lows, as the chart shows. The drop in nominal yields was likely exacerbated by foreign buying and short covering – or investors force to close out bets that yields would head higher. Shifting sentiment drove equity market volatility too – with large sectoral moves that quickly reversed.

The big picture: We believe these swings are to be expected, given the wide range of potential outcomes beyond the current restart of economic activity. In a noisy and unprecedented economic restart, having an anchor is all the more important. We stick to our new nominal investment theme: Major central banks are slower to respond to rising inflation than in the past, keeping nominal bond yields lower and real rates negative – a positive for risk assets.

We believe the powerful restart of economic activity remains the key story for markets, and it’s too early to make the determination that new virus strains will derail this. The evidence on vaccines is still consistent with their expected effectiveness, in our view, as reflected in hospitalizations significantly lagging the recent rise in cases due to the delta variant. Rising cases in the U.S. are to be expected – given the swift reopening and the emergence of the delta variant. The increase in cases in Europe has come quicker than many foresaw, yet pressure on hospitals is limited so far. The UK remains a test case to monitor — and we are watching for a decline in the rate of growth of new cases after a recent spike. Asian and emerging market economies struggling with vaccination rollouts are suffering most in terms of health outcomes and mobility restrictions. Yet vaccines remain the way out, barring vaccine-resistant variants or new evidence on vaccine effectiveness, in our view.

While virus dynamics are uncertain, we remain confident that the policy paradigm has changed: many central banks are now attempting in different ways to overshoot inflation targets to make up for past misses. Our analysis suggests the drop in yields since May was primarily due to a decline in the term premium – the additional compensation that investors demand for moving further out the yield curve in duration. This represents a partial unwinding of a spike in the term premium seen since mid last year. We have also seen a reversal in market expectations of the U.S. “terminal” rate – or the neutral rate consistent with the Fed’s objectives. Markets are pricing in around four quarter percentage point rate hikes by 2025, roughly half what they priced in April – moving back toward our new nominal theme.

The bottom line? We believe the economic restart is real – but it is a restart, and will eventually taper back to the pre-covid trend. We see nominal yields rising far less in response to inflation than during similar episodes in the past. Yet still believe the direction of travel should be higher for nominal yields – and this is why we remain underweight Treasuries and government bonds overall, both on a tactical and strategic basis. Negative real interest rates provide a positive backdrop for equities, in our view. Markets may overreact to economic data and other news flow with thin liquidity in the summer, amid an unusually wide range of macro outcomes, in our view. Yet for now we see the restart intact and the new nominal holding – and would consider any temporary sell-offs as opportunities to readjust portfolios into a pro-risk stance.

Assets in Review - Negative real yields underpin equities

Market backdrop

Risk assets have rebounded from their swoon earlier in the month, with bond yields bouncing off lows. Such sharp price swings are the latest example of markets overreacting while grappling with the unusually wide range of potential outcomes that lie beyond the restart of economic activity. The ECB tweaked its forward guidance by making a lift-off in rates conditional on inflation durably reaching 2%, well within its forecast horizon. This is consistent with our new nominal theme, which holds that central banks will be slower to raise rates in the face of rising inflation than in the past.

Week Ahead

  • July 27 – U.S. consumer confidence

  • July 28 – FOMC policy decision

  • July 29 – U.S. second-quarter GDP

  • July 30 – Euro area second-quarter GDP and inflation

All eyes will be on the Fed this week. We see the central bank likely upholding its accommodative policy stance as the strong activity restart in the U.S has led to unusual supply and demand dynamics and volatile near-term growth and inflation data. We don’t see the Fed discussing a tapering of asset purchases imminently, and a discussion later this year doesn’t mean a lift-off from near zero policy rates is close, in our view.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of July 19th, 2021 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

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Market Update by Liontrust – Q2 2021

Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.

Market review

A consistent theme in the last four quarters has been the outperformance of low-quality bonds. This trend continued in Q2, as CCCs produced an average return of 4.5%, while the market in general produced a return of 2.4%, with US high yield returning 2.8% and Europe returning 1.6% (all in US dollars).

Boosted by a healthy and stable oil market in recent months, the energy sector was the biggest contributor to index returns with, for example, the US energy sector producing a return of 6.1% in the quarter. The energy sector is a much higher proportion of US high yield than its European counterpart, which helps to explain the US outperformance.

The outperformance of lower-quality high yield continued right up to the end of the quarter, when equity markets were selling off on variant concerns and the strong bid for treasuries continued. Are we living in strange times?

 

Fund review

Over the quarter, the Liontrust GF High Yield Bond Fund (A1, accumulation class, total return in euros) produced a return of 1.5% versus the ICE BAML Global High Yield index’s (euro hedged) 2.2%*.

The main drag on relative performance was simply not owning enough energy-related bonds. Although the Fund’s two holdings, Enquest and Neptune, contributed positively, good returns from these bonds were not enough make up for our large underweight to this sector. As a reminder, we seek to avoid large accumulations of risk in thematic, cyclical sectors, regardless of the index. Therefore, it is to be expected that relative performance will be impacted when the energy sector is the standout.

The next biggest detractor on both a relative and absolute basis was the Fund’s holdings in Bausch Health. Bausch surprised the market by announcing a more aggressive attitude towards debt in its forthcoming reorganisation, which led to its various bonds selling off in the range of 6-7 percentage points, a meaningful amount given the stable returns and lack of volatility in the wider market. Although not ideal, we believe Bausch will seek to quickly reduce debt following the reorganisation, which includes selling its eyecare business, and we are happy to hold on to the position with the bonds yielding around 6%.

More positively, the Fund benefitted from good performance from bonds we’ve added in the relatively recent past such as travel and insurance company Saga, packaging company Kloeckner and specialist financer Burford. Meanwhile, high conviction holdings such as Ardagh (packaging), AMS (sensors), Cheplapharm (pharma) and IMA (packaging machinery) were amongst the highest individual positive contributors to returns.

We view a return of nearly 2% return in the quarter and over 3% year to date, as a pretty good performance from the Fund and asset class in the wider context of bond returns so far in 2021. Of course, high yield is largely about credit risk rather than interest rate risk, providing a resilience in a world which has the spectre of inflation.

To the extent that there is interest rate risk in the high yield market, we have managed the Fund with some hedges in place since the start of the year in order to protect returns in the event of a rising interest rate environment. In Q2, these hedges cost the Fund around 0.11%, with US interest rates in particular lower than they were three months ago.

During the quarter, portfolio activity has been relatively modest. We participated in new issues from telecoms giant Vodafone, listed US payments technology company Paysafe and a blood plasmaspecialist pharma company called Kedrion.

At the margin, despite high yields being ever harder to come by, we have reduced exposure to some of our riskier, higher yielding holdings. For example, we reduced the holding in oil producer Enquest from 1.75% to 1.25% and have cut CCC rated Kloeckner to 0.5% from 0.75%, taking profits.

Outlook

With yields and spreads compressed, we view carry as the main source of returns in the second half of the year. We remain reluctant to chase yield and, as noted, at the margin have reduced exposure to companies that would be most vulnerable if economic conditions were to worsen. Of course, that is not our base case as economic conditions are improving – heating up even – as the increasingly vaccinated population tiptoes back to normality. Rather, the extra compensation for lending to less resilient companies is now wafer thin, and we would rather not take outsized risks with clients’ money for an extra 1-2% yield.

The yield on the Fund is low by historical standards but reasonable compared to the current available, liquid alternatives. Rest assured that we are sticking to our process and philosophy and quality bias. The Fund has recently reached the milestone of its three-year anniversary. We would like to take this opportunity to thank clients for supporting the Fund. As ever, we seek to continue to produce good investment performance and do so in a manner consistent with our process and philosophy.

Article Image - Liontrust Q2 2021 Update


Liontrust Key risks & Disclaimers:

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not
guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject
to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Investment in the GF High Yield Bond Fund involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income
securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate
of interest. Bond markets may be subject to reduced liquidity. The Fund may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may
have the effect of increasing volatility.

Issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated
investment business.

This document should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation
to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. It contains
information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content
of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been
used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust.
Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Liontrust Fund Partners LLP. No information has been omitted which would render the reproduced information
inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information
purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available
in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding
the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at
the time of the initial purchase for an investment. Any income you get from this
investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The
performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest
should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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