2018: The View for U.S. Fixed Income
2018: The View for U.S. Fixed Income
Tim Paulson, Investment Strategist
The Market Environment
Well, 2017 was a strong year for risk assets. Characterized by low volatility-- and accelerating global growth prospects. As one would expect in such an environment, higher beta risk assets such as equities, high yield, and emerging markets were the primary beneficiaries. Heading into 2018 we expect to see more of the same, albeit with lower overall return goals. But really fueled by a combination of central banks around the world-- a synchronized global growth story that continues to accelerate, and a strong technical backdrop of a significant amount of liquidity in investor hands that will continue to stabilize markets.
The Central Bank Effect
While much has been made of the Fed hiking and potentially tightening monetary policy, the fact is that monetary policy-- financial conditions have rarely been this easy in the United States. And when you look around at the rest of the world, global central banks-- remain very accommodative. Why do accommodative central banks matter so much for markets? Well, first, it helps keep financial conditions easy around the world.
Second, it creates a market environment in which investors are continually incentivized to move into riskier investments in order to achieve higher returns. Nowhere is this more evident than in Europe and Japan, where sitting in cash costs money, and sovereign debt has negative yields. This dynamic tends to lower return expectations across all asset classes, while pushing up the prices of risk assets in general. And it tends to stabilize markets and dampen volatility.
The Global Growth Story
Well, accommodative central banks only get you so far if you don't have solid underlying fundamentals. But we've reached a point now where many countries have emerged from recession, and virtually the entire world is now participating in a global growth story. We're in a far better place than we were a year ago. And you can see that in the form of stronger earnings, higher equity markets, and tighter credit spreads.
Risk and Opportunity in 2018
Our base case for 2018 is for continued growth. Of course there are always risks. Geo-political risks are ever-present. We could see waves of populism change the political landscape in Europe. You could see data turn sour and-- increased threat of recession. The question, of course, is: Are you getting fairly compensated for those risks? Generally speaking, when we consider interest rate risks our takeaway is no. But when we think about credit risk, for the most part our answer is yes. Whether we're talking higher grade corporate credit, commercial mortgages, even high yield, we believe we're being fairly compensated for those risks. Remember that markets are just as aware of the bad news as they are of the good news. It's all pretty evenly priced in.
Generally speaking, higher beta asset classes should be the strongest performers in 2018 if growth continues as expected. The real question when you get these periodic market downturns, which will always happen, is whether the fundamental outlook for global growth has changed, or whether our view of central bank accommodation has changed. As long as those remain intact, those are going to continue to be buying opportunities.
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