Market Intelligence April 2017
At Madison, our Investment Committee devotes a great deal of energy visiting with and tracking some of the great minds in today’s investment world. This disciplined effort keeps us abreast of current thinking and varying perspectives of some of the foremost thinkers in the money management field. These insights and professional relationships help inform our portfolio decision-making for our clients.
One piece of research recently caught our eye due to its unusual optimism. Our experience has shown that fixed income portfolio managers are inherently risk adverse and keenly focused on downside risks. It makes sense—the biggest risk to a bond manager is default of debt payments, so they are usually a somber bunch.
Chief Investment Officer of Legg Mason’s Western Asset Management, Ken Leech, recently provided a fairly sanguine view on the fixed income market in light of rising interest rates (bond prices decline when interest rates rise) and how a contrarian view of the economy can suit investors well over the long-term.
“Since the onset of the financial crisis, we have been steadfast optimists that the global and US recoveries would be ongoing. Our feeling is and has been that despite the enormous headwinds facing global growth, the natural economic healing process, the persistence and ingenuity of the human spirit, and continued policy support would underpin the global and US recoveries.
A year ago such economic optimism looked horribly misplaced. Fears of a potential global recession were accelerating as oil prices dropped to $25 a barrel, and fears of an impending economic collapse in China helped send global equity and other risk markets into a tailspin. When viewing the US as a meaningful, but component part of the broader global ecosystem, the need to protect against these potential downside events was crucial for controlling risk, and ultimately proved very beneficial. Our belief was that the enormous policy accommodation globally was actually accelerating, particularly in China. We thought the case for growth turning up there, rather than down, was becoming stronger. We also believed that commodity prices had overshot to the downside. In this environment, we felt adding to our highest conviction positions was warranted, particularly as we had mitigated portfolio drawdown with diversifying strategies. Fortunately, this optimism was rewarded.”
“We feel valuations are fair, even if no longer overwhelmingly compelling. If valuations have become less generous, however, it is because the underlying fundamental story for credit keeps improving. The US economy’s growth rate has improved since the first half of last year. The prospect of substantial credit-positive policy proposals is on the immediate horizon. We are most specifically focused on the prospects of deregulation for business as well as corporate tax reform/ reduction. Despite our expectation that progress would be slower than the original optimism set forth by the new White House Administration, we still believe we will see substantial implementation this year. On infrastructure spending, the jury is still out; our expectation is that it may become next year’s business.
There is also room for optimism on the global recovery front. Global inflation looks to have finally stopped declining. The extraordinary monetary effort seen in developed nations to arrest this decline finally appears to be bearing fruit. We must remain cognizant that this rate is still near zero. Global policymakers therefore must continue to support recoveries meaningfully. Japan and Europe most particularly are nowhere near their inflation targets, and we expect years of continued monetary support. This combination of increased global growth and inflation—buttressed by continuing monetary accommodation—provides continued interest in the US credit sectors, which are both higher-yielding and in a better cyclical environment than their international counterparts.”
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