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Market View

In 2017, fixed-income markets performed the opposite of virtually all that Wall Street had predicted. What happened, and how did our forecasts turn out?

(In 2017, the fixed-income markets did not follow the path that many had predicted. Political changes, both in the United States and abroad, consequent policy implications, and their impact on investment risks and opportunities were still being assessed as the year began. In this article, we review some of Wall Street’s expectations for the fixed-income market in 2017 and attempt to answer the question “What went wrong?” Next week, we assess the accuracy of forecasts for the equity markets in 2017.)

The final quarter of 2016 was a challenging period for the U.S. bond market. Interest rates had jumped sharply in the post-election period on expectations of faster economic growth and inflation as a result of the policies of the new administration. The yield on the 10-year U.S. Treasury bond finished 2016 at 2.4%—more than 100 basis points (bps) above the historical low point reached in July of that year. Many had expected that this would continue into 2017: the call was for increasing inflationary pressure and higher interest rates, leading to a negative environment for bonds.

With the year 2017 now behind us, we can state the obvious: many of those expectations did not come to fruition, especially in terms of sector performance (see Chart 1).


Chart 1. Actual 2017 Results in the Fixed-Income Markets Were Better Than Forecast
2017 Total Returns 

Source: Bloomberg Barclays, JP Morgan, and ICE BofAML. US Treasury=Bloomberg Barclays U.S. Treasury Index. Agency MBS=Bloomberg Barclays U.S. MBS Index. CMBS=Bloomberg Barclays CMBS Index. US Aggregate=Bloomberg Barclays U.S. Aggregate Bond Index. Bank Loans=Credit Suisse Leveraged Loan Index. Municipals=Bloomberg Barclays Municipal Bond Index. IG Corporate=Bloomberg Barclays U.S. Corporate Bond Index. IG Corporate BBB=Bloomberg Barclays U.S. Corporate Bond Index - BBB. High Yield Corporate=Bloomberg Barclays U.S. High Yield Index. EM Corporate=JP Morgan CEMBI Broad Diversified. Long Muni (22 yrs.)=Bloomberg Barclays Long Municipal Bond (22 year+) Index. Municipals (BBB)=Bloomberg Barclays Municipal Bond Index -BBB. EM Sovereign (USD$)=JP Morgan EMBIG. High Yield Muni=Bloomberg Barclays High Yield Municipal Bond Index. High Yield Corp. CCC=ICE BofAML U.S. High Yield CCC Index. EM Sovereign (local)=JP Morgan Global Bond Index-EM.
*Municipal bond index returns do not reflect the additional effect of the tax-free status on municipal bond income. The municipal market can be affected by adverse tax, legislative, or political changes, and by the financial condition of the issuers of municipal securities. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply.
Past performance is no guarantee of future results. Performance during other time periods may have been different or negative. Indexes are unmanaged, do not reflect the deduction of fees and expenses, and are not available for direct investment. For illustrative purposes only and does not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment.


Investment Grade
Within investment-grade bonds, the move to higher rates did not come about, resulting in a solid year of returns across most segments of fixed income. The yield on the 10-year Treasury, for example, remained below its initial level for most of 2017, before increasing by more than 40 bps in the final weeks of the year owing to signs of faster economic growth, in the United States and abroad, and positive sentiment resulting from the enactment of tax reform. The Bloomberg Barclays U.S. Aggregate Bond Index (a common benchmark for the broad U.S. bond market) delivered a return of 3.5% for the year ended December 31, 2017. While not a huge return relative to the massive rally in U.S. equities, this represented a decent return, given the low level of market yields coming into 2017 and the expectations for higher rates.


Chart 2: In a Surprise to Many, 10-Year U.S. Treasury Bond Yields Ended 2017 Near Where They Began
10-year U.S. Treasury bond yield (year ended December 31, 2017)

Source: Bloomberg. 
Past performance is no guarantee of future results. Performance during other time periods may have been different or negative. Indexes are unmanaged, do not reflect the deduction of fees and expenses, and are not available for direct investment. For illustrative purposes only and does not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment.


Corporate bonds outperformed government-related securities, with investment-grade (as represented by the Bloomberg Barclays U.S. Corporate Bond Index) and high-yield corporate bonds (as represented by the ICE BofAML U.S. Corporate High Yield Index) generated returns of 6.4% and 7.5%, respectively, compared to a 2.3% return for the representative benchmark Bloomberg Barclays U.S. Treasury Index.

Many fixed-income observers had voiced concern about corporate credit coming into 2017, as spreads started the year below their long-term averages, after a strong rally in 2016. But the market surprised investors with continued spread tightening, as investment-grade corporate and high-yield corporate spreads tightened by 30 bps and 65 bps, respectively, as a result of positive economic growth and improving credit fundamentals.

High Yield
High yield is one area in particular that many pundits were sounding the alarm bells for going into 2017. A few headlines suffice to illustrate: “Why You Should Be Wary of Junk Bonds” (The Wall Street Journal, January 9, 2017); “Why Investors Should Worry about Junk” (WSJ, March 24, 2017); and “Investors View Junk Bonds as Most Overvalued in a Decade” (WSJ, March 14, 2017).

A common theme was that since the current credit cycle had gone on too long, and spreads were well below their long-term average, there was little opportunity left for high yield. But, as our regular readers know, Lord Abbett had a different view. Credit cycles don’t need to end due to old age or because spreads are below average. There have been periods when credit spreads remain below average for an extended period.

One year ago, we suggested that in an environment of continued positive economic growth, accompanied by low defaults, high yield could continue to do well: “In terms of ratings categories, we think the ‘BB’ rated segment of high yield is richly valued, while there remain some compelling opportunities within ‘CCC’ rated issues. Since we are positive on credit fundamentals and consider that valuations are still attractive, we think the ‘CCC’ rated category will remain appealing, at least in the near term.”

This view ultimately proved to be prescient, as high-yield bonds outperformed investment-grade bonds by a wide margin. Within high yield, the ‘CCC’ segment (as represented by the ICE BofAML CCC & Lower U.S. High Yield Index) led the way with a return of 10.6%, outperforming the broad high-yield index (as represented by the ICE BofAML U.S. High Yield Index) by more than 300 bps, for the year ended December 31, 2017.

There were bumps in the road along the way, especially during a period of credit-spread volatility in November 2017. Once again, many observers pointed to this pullback as a sign of the beginning of the end of the high-yield cycle. From our perspective, however, that episode was the result of sector-specific and company-specific issues concentrated in certain industries facing secular headwinds, rather than a symptom of broader high-yield credit market fundamentals. We have since seen relative stability return to the high-yield sector in the final weeks of 2017.

Not only did many of Wall Street’s experts miss the rally in high yield but also many investors did as well. According to Morningstar mutual fund flow data, high-yield bond mutual funds witnessed more than $20 billion in outflows in the first 11 months of 2017, for a total of more than $40 billion in outflows over the trailing five years. So, while the high-yield index has generated three times that of the return of the Barclays Aggregate over the past three years, many investors have not benefited. For those who say those investors were “chasing yield” in the high-yield market, it’s difficult to make that claim when looking at fund-flow data.

For 2018, our base case is for positive economic growth, and an environment of low defaults, leading to a positive backdrop for high-yield credit.

Emerging Market Debt
As we entered 2017, many had expressed concerns over the outlook for emerging market debt. Emerging market bonds experienced selling pressure after the November 2016 election, based on fears that higher U.S. interest rates, a strong dollar, and new trade policies could negatively impact emerging market countries. (See, for example, “Investors Soured on Emerging Markets in 2016—U.S. Dollar Strength May Trigger Further Stress in Emerging Markets, Analysts Say,” The Wall Street Journal, January 4, 2017.)  

But many of these fears were not realized: long-term Treasury yields stabilized and the dollar strength of 2016 turned into dollar weakness in 2017. As a result, global bonds, and emerging market debt in particular, generated strong returns. U.S. dollar-denominated emerging market corporate bonds generated returns of 8.0%, while the longer-duration emerging market sovereign bond index rallied by more than 9%. Emerging market sovereign debt denominated in local currencies led the way, with returns in excess of 15% on the year.

Looking forward to 2018, we believe the backdrop for emerging markets remains positive. According to Lord Abbett portfolio manager John Morton, “Our long-held positive stance toward emerging-market [EM] corporate debt has been supported by two factors: a benign global backdrop and an improving macro outlook for many EM economies, particularly in terms of growth. With 2018 drawing near, we maintain our constructive view of the EM corporate story.”

Municipal Bonds
The challenging period of the fourth quarter of 2016 was even more difficult for municipal bonds. In addition to the fears of higher rates and inflation affecting U.S. Treasury securities, municipals also faced questions about the potential change in tax benefits due to tax reform, leading to reduced demand, and the potential for higher issuance due to infrastructure spending, leading to increased supply. This mix of potential issues led to significant mutual-fund outflows. During the two-month period following the November 2016 election, for example, municipal bond mutual funds experienced $28 billion in net outflows, according to Morningstar.

But Lord Abbett had a different view. Yes, there was the potential for higher interest rates, but history has proven that basing investment decisions on a prediction of future interest-rate moves is inherently risky.  Yes, too, there was the potential for tax reform, but history has illustrated that changes in tax code have very little correlation with municipal-bond performance. And, yes, significant fund outflows can cause temporary price pressure on bond prices, but history has suggested that, over time, fundamentals beat out technical factors, and periods of large outflows are typically a good time to invest.

Given that underlying credit fundamentals remained sound, and year-end selling led to higher yields and credit spreads, we thought it was an opportune time to put money to work in municipals, and so noted that “the market is full of uncertainty, but given the long-term return profile, the higher yields and more attractive relative value available in the market today, investors may want to take another look at allocating to tax-free bonds.”

Municipal investors were rewarded in 2017, with the 5.5% return of the Barclays Municipal Bond Index, soundly beating the 3.5% return of the taxable Barclays Aggregate Index—and that’s before the benefit of municipal’s tax-exempt status. Lower-rated municipals led the way, with the Barclays High Yield Municipal Index rallying 9.7%, well ahead of the high-yield corporate bond market. The reversal of fortune in municipals is a good illustration that a long-term strategic allocation to municipals is a more prudent approach than trying to time the market, making tactical buy and sell decisions based on the headline of the day. [All data are for the 12-month period ended December 31, 2017.]

Recently, Daniel Solender, Lord Abbett partner and director, said: “We believe 2018 likely will be a positive year for the municipal-bond market, although expected returns likely will not be as high as they were during 2017.” While the new tax bill creates some level of uncertainty, one impact is definitely a positive for municipals. Solender further said, “While many tax exemptions are going away or are being capped, the municipal bond-interest tax exemption is staying. Because there are now fewer tax-exempt investment alternatives, we expect demand for municipal bonds to increase.”

At the same time, supply is expected to be lower in the early 2018, as a large amount of supply was pulled forward to 2017. Solid credit fundamentals, paired with attractive relative value and supply/demand dynamics, should continue to provide a good environment for municipal bond investors.

Every new year brings with it a new series of market predictions. As fixed-income performance in 2017 illustrated, those predictions do not always come to fruition. Perhaps it would be best to not over-react and restructure your portfolio based on the consensus forecast of the day. Visit us next week to see how the equity market experts fared in 2017.


This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Moreover, the specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. No investing strategy can overcome all market volatility or guarantee future results. The municipal market can be affected by adverse tax, legislative, or political changes, and by the financial condition of the issuers of municipal securities. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

Glossary of Terms

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.

basis point is one one-hundredth of a percentage point.

The Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The Index covers the U.S. investment-grade fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. Total return comprises price appreciation/depreciation and income as a percentage of the original investment.

The Bloomberg Barclays U.S. Corporate Bond Index includes all publicly held issued, fixed-rate, nonconvertible investment-grade corporate debt. The index is composed of both U.S. and Brady bonds.

The Bloomberg Barclays U.S. High Yield Index covers the universe of U.S. fixed rate, non-investment grade debt.

The Bloomberg Barclays Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long-term investment-grade tax-exempt bond market. Bloomberg Barclays Municipal Bond Index – BBB is a component of that Index.

The Bloomberg Barclays High Yield Municipal Bond Index is an unmanaged index consisting of noninvestment-grade, unrated, or below Ba1 bonds.

The Bloomberg Barclays U.S. Treasury Index is the U.S. Treasury component of the Bloomberg Barclays U.S. Government Index. The index includes public obligations of the U.S. Treasury with a remaining maturity of one year or more.

The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market.

The ICE BofAML CCC & Lower US High Yield Index is a subset of The BofA Merrill Lynch U.S. High Yield Index including all securities rated CCC1 or lower.

The ICE BofAML U.S. High Yield Index tracks the performance of US dollar-denominated below –investment-grade corporate debt publicly issued in the U.S. domestic market.


The JPM Emerging Markets Bond Index Global (EMBI® Global) tracks total returns for US dollar-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans, Eurobonds.

The JPM Government Bond Index-Emerging Markets (GBI-EM) The is the first comprehensive, global local Emerging Markets index, and consists of regularly traded, liquid fixed-rate, domestic currency government bonds to which international investors can gain exposure. Variations of the index are available to allow investors to select the most appropriate benchmark for their objectives. 

A Note about Indexes: Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Indexes depicted herein are for illustrative purposes only and do not represent any specific portfolios managed by Lord Abbett or any particular investments. Other indexes may not have performed in the same manner under similar conditions.

The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.


  Market View
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