Insiders' Views on What's to Come in Fixed Income, Economy

As the market responds to the $2 trillion rescue package agreed on by Congress Tuesday night, the impact of the coronavirus on all parts of the market can't be overstated, especially in the fixed income market, noted experts this week in two webinars, one sponsored by Northern Trust Asset Management and the other by Envestnet.

Colin Robertson, NTAM global head of fixed income, noted that the speed of rates dropping, from 2.50% to 0.25% was "unprecedented," adding that in the United States, rates still could drop even more "precipitously."

He pointed out that in the past stimulus packages have had impacts on different areas of the fixed income market. After stimulus started, the best performing markets have been high-yield bonds and emerging market bonds.

However, year to date, high-yield bond performance is down more than 30%, largely because "investors are indiscriminately selling what they can," he said. Spreads have widened — high-yield adjusted spread was close to 1,000 and investment grade was "more dramatic" at around 330" — and he doesn't see this "snapping back."

Further, the default rates of high-yield bonds are being driven by energy. Now the rate for high-yield defaults is 4.5%, but "expectation is energy could be in the 20-30% range," he said. He added that flight to safety and oil prices will hurt the emerging debt market.

He added:

Liquidity is the key indicator to watch
Monetary policy may help liquidity, but fiscal policy will be key to reducing uncertainty
Be careful on trying to "time" the market

Other Warnings

Avoiding timing the market was a theme echoed by experts who met online with Tim Clift, Envestnet's chief investment strategist, in a webinar on Tuesday. Stephen Auth, chief investment officer of equities at Federated Hermes, said that odds of picking a bottom were low and people "could be destroyed in the process." He noted the best thing is to hold on, "the worst thing is to panic and sell."

Monica Erickson, portfolio manager for DoubleLine, agreed that the speed "at which the [fixed income] market has fallen is unprecedented," adding that the credit spread widening that happened in 2008 over three months happened now in a week.

"What happened last week was the largest outflow we've ever had of the investment-grade market both in total dollar terms and as a percent of AUM," she said.

She believes the Fed is doing the right thing, yet the moves were "fairly small" compared to the total size of the fixed income market.

This market is "more interesting" than other bear markets from a behavioral standpoint, stated Peter Mallouk, president and CEO of Creative Planning. Although 2008-2009 was much worse because there was more systemic risk, "the difference is the iPhone just came out." With social media platforms rapidly spreading the dangers comes the "existential risk" of worrying of dying due to the coronavirus.

"That tremendous fear coupled with everybody having an iPhone coupled with everyone having to stay at home coupled with no sports on TV, which could preoccupy at least some people, and you have the perfect behavioral mess," he said.

One result is what we've seen: record outflows across all asset classes. "This is not a normal bear market in the sense that there was no deterioration of fundamentals preceding it. … A lot of people think the government really shortened that bridge [with the stimulus package] but I don't know. We'll be tied to what happens on the health care front right now. … But [in the meantime] we're going to see a lot of people making mistakes."

Auth said "there's a lot of '87 in this market" as "you're seeing a lot of forced liquidations" with hedge funds unwinding, but he doesn't see pensions selling. "This is 4-6 weeks for it to peak in U.S. and a quarter of poor economic activity and then there will be a rebound."

The key is to get through the health issue, then the economic reaction, and then the policy response, "which is what is most likely to either to cause economic contraction to become prolonged or shortened." He said it's good that the Fed "will do everything it takes" to provide liquidity to the market.

Erickson said "there are more risks out there." She added that the market structure of the investment grade field is much different than before, and downgrades just are starting now. She noted that about $250 billion could go from investment grade to high yield, according to a report from JPMorgan.

"The high-yield market now is about a $1 trillion, so that's about 25% of the market that would get absorbed."

Mallouk said that we aren't yet near capitulation levels, but if the death toll accelerates, the market won't react well. That said, he said the worst things investors could do would be to get into cash, get into an industry that doesn't recover, like energy, or bet on a company that can't recover.

He added that he was optimistic that once we get through the worst of the health care issue, the economy will be "resilient."

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