Despite the jitters of the last few weeks, low interest rates are here to stay. One can quibble about whether the Fed will hike in December but ultimately it is going to go slow. Elsewhere – say in the UK, Europe and Japan – central banks continue cutting rates. The fact of the matter is that growth is sub par and interest rates are not going anywhere soon. Current levels support a number of asset classes. Our highest conviction centres around US high yield bonds, Mexican bonds and European Reits.
US high yield
The US economy is in a “Goldilocks” zone for high yield. It is not growing hot enough to generate aggressive rate hikes but neither is the economic performance cold enough to generate corporate defaults. While there has been concern of US energy companies overstretching themselves in recent years, we focus on non-shale names that constitute roughly 85 per cent of the US high yield market.
With spreads still around 500 basis points over government bonds, the credit risk embedded in high yield remains attractively priced. Ultimately, the yield of around 6.5 per cent remains appealing. This yield will draw investors in over time and the prices for those same bonds are likely to appreciate.
Mexican bonds Outside of the US, low interest rates are boosting the attractiveness of emerging market bonds. Our spotlight is on Mexican bonds, as these stand to benefit from a growing economy that has a currency at the cheapest it has been for nearly two decades. We have initiated this position in recent weeks as the peso has lagged the broader emerging market rally, although the Mexican economy is in much better shape. Mexico is growing, much unlike Brazil and Russia, for example. And that growth depends on the US. This dynamic stands it separate from the bulk of emerging markets, which are reliant on China for their growth.
Closer to home we recognise an opportunity in European Reits. Europe is at the heart of the negative interest rate regime and in this environment both institutions and households are likely to use property as an alternative investment vehicle.
Our focus is on core eurozone property and our particular preference for German and northern European exposure is implemented through a basket of stocks in names we like. European property presently remains inexpensive, even though valuations are good. However, we are confident that we have accessed the marketplace at the right time before the asset class becomes too expensive. So for as long as low rates persist, it is our opinion that these asset classes will deliver in a yield starved environment.
Christopher Mahon is director of asset allocation research at Baring Asset Management