Sage Advisory, Author at Sage Advisory

When Will the Party End for the US Corporate Bond Market?

Posted on May 4, 2017February 23, 2018 by Sage Advisory

There comes a point at every great party when the festivities start to wind down. The crowd dwindles, the snacks are gone, and the beverage consumption comes to a screeching halt. Eventually the lights come on (or the sun comes up) and the party is over. One of the most common questions we’ve been hearing from clients is ‘when will the party end for the US corporate bond market.’ After the yearlong rally in corporate credit spreads, are we due for a corporate bond market correction or if there is still room for spreads to tighten?

To address this, we take a historical perspective on corporate spread levels over the past five years.

The most recent example of spread widening was in early 2016, sparked by the decline in commodity prices. Following the bottoming out of commodities, corporate spreads rebounded to their current level, 119, which is on the tight end of the range. Yet, 119 is still wide compared to the sub-100 levels achieved in mid-2014.

A look at corporate fundamentals over this same period shows an abundance of activity as companies took advantage of historically low rates and high demand for corporate bonds to lever up balance sheets for M&A, buy-backs, and other high-capital maneuvers. At the same time, revenue growth over the past three years has been lagging, with negative numbers last year.

On the positive side, there are signs that balance sheet deterioration is slowing down and stabilizing. Profit margins have also been stable and remained high, while cash to shareholders as a percentage of EBITDA is at a multi-year low.

As a result, corporates have been issuing record amounts of debt year after year with nearly 1.2 trillion issued in 2016, and 2017 is on track to beat this figure. In fact, issuance has grown every year since 2010.

Yet, this tremendous growth has not resulted in any dip in demand, with new issues still typically multiple times oversubscribed and with little to no concessions to existing issues.

Where has the insatiable demand for corporate bonds come from over the last few years? The most dominant factor has been central bank actions in the US and abroad. With quantitative easing, central banks grew their balance sheets by buying high quality assets, such as US Treasuries. With less high quality assets around, investors have been forced to move on to riskier assets such as corporate bonds.

While the US central bank put a halt to its quantitative easing expansion, Japan and Europe were still in the middle of their buying spree. A strengthened US dollar and rates augmented the attractiveness of US yields relative to Japan and Europe, stoking additional foreign demand for US corporates.

While many central banks have halted or reduced their quantitative easing, none have started to unwind. Even the US, which will likely lead the pack, is not expected to begin until 2018 and beyond.

In the near-term, we think the technical bid caused by central bank actions coupled with stabilization in corporate fundamentals will give support to corporate spreads levels, with the potential for some incremental tightening.

The party isn’t over quite yet.

For more insight, please visit our Fixed Income Perspectives or reach out to the team at 512-895-4130.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. This report is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Is Too Much Optimism Priced Into Risk Markets?

Posted on March 28, 2017March 28, 2017 by Sage Advisory

Macro conditions have continued their positive trajectory throughout the first quarter of the year, with US economic activity at the highest pace post-crisis and the labor market showing healthy job creation and wage growth. Meanwhile, global inflation is increasing and downside risks have largely subsided.

Markets are responding with a strong rally in equity markets, higher bond yields, and tighter credit spreads. With this abundant optimism, we would caution against over-bullishness given the fact that current sentiment is largely reflected in current prices.

Risk assets may be prone to bouts of policy-related volatility as the new administration works to implement fiscal stimulus and the Fed tightens monetary policy in response to financial conditions.

Finding Opportunities in Fixed Income

After a sharp spike higher in the fourth quarter of 2016, yields have been largely range-bound this year. The Fed’s forward guidance on rate hikes, coupled with an uptick in inflation data, means that yields could drift modestly higher over the next two quarters. However, we continue to believe that strong global demand for US fixed income will balance tighter monetary policy, keeping rates contained.

Within our asset allocation strategies, we are slightly short duration, maintain an overweight to credit, and hold an allocation to both preferreds and bank loans. Additionally, we recently increased an allocation to TIPS, which look attractive when compared to traditional measures of inflation, including core CPI and wages.

International Equities Show Promise

We continue to be constructive on equities and remain focused on relative value opportunities, holding an overweight to core international markets, which are attractive from a valuation perspective when compared to US equities. We believe developed international equities will benefit from global reflationary trends, weaker currencies, and still favorable monetary policies relative to the US.

As we move towards year-end, policy and politics will continue to dominate the conversation. As optimism wanes, volatility will most likely increase. The best way to weather volatility is by maintaining a sound risk management discipline rooted in relative valuation and fundamental analysis.

For more insight, please visit our Asset Allocation or reach out to the team at 512-895-4130.

3 Key Macro Themes for the First Half of 2017

Posted on February 2, 2017February 2, 2017 by Sage Advisory

While politics and fundamentals continue to drive the investment outlook, at Sage, we believe it is the global macro landscape which is central to investing in the first half of 2017. As the new year unwinds, we see an overall favorable backdrop for risk assets given improving global data, robust earnings outlooks, and fiscal stimulus expectations. At the same time, we anticipate slowdown in the “trump trade” – or bullish near-term momentum – given that much of the optimism is already priced into markets. Still, the macro picture remains dominated by global monetary policy, fiscal policy follow-through and a volatile political landscape, leaving markets vulnerable to wide swings, overshooting and undershooting fair value. In greater detail, here is what we at Sage see as the three main factors influencing the next six months – and how we are adjusting accordingly:

Expect a more stable first half for fixed income

After the historically poor fourth quarter for fixed income, we expect both a more stable first half and some upside potential in the first quarter. We believe the rate sell-off was overdone into year-end and expect yields to remain in a fair value range during the first half of 2017. Increased equity volatility is also on the horizon, with some profit to be had in risk assets, and a slowdown in the pace of improving economic data supportive of core fixed income returns. While rate hikes combined with upside growth and inflation potential will continue to apply upward pressure to rates, we expect this to materialize later in the year. As in 2016, we expect upside opportunities in the first half and the second half to be more about risk mitigation.

Look to international diversification within equity allocations

We believe developed international markets will benefit from the global reflationary trend, weaker currencies, and still favorable monetary policies relative to the US. In addition, international markets, particularly Europe, are attractive from a valuation perspective. Given how much optimism is already priced into US markets, and the level of pessimism toward international markets, we see greater upside overseas in the next few quarters.

Take advantage of relative value opportunities

Two markets we believe had run too far into year-end were rates and the dollar. To this end, we have pursued relative value opportunities by adding duration and Gold to our strategies in order to benefit from the rollover in both rates and the dollar. While it may be tempting to focus on the domestic front for the first half of 2017, discounting the macro picture will do you no favors. With stability for fixed income, optimism for international equities and an emphasis on relative value investing, 2017 provides ample opportunities for those who invest wisely.

For more insight, please visit our Asset Allocation and Fixed Income Perspectives or reach out to the team at 512-895-4130.

Trump’s Impact on Fixed Income Markets

Posted on January 13, 2017February 2, 2017 by Sage Advisory

While the country prepares for the first hundred days of a new Commander-in-Chief, contrasting market dynamics warrant a closer look for investors of all types. Whether you’re following the Treasury market or your Twitter feed, here are a few factors to keep in mind when it comes to making investment decisions over the next few months.

Trump-onomics call and response

What exactly underlies so-called “Trump-onomics”? It is the aggregate effect of potential tax cuts, fiscal stimulus and de-regulation, which are presumed to be cornerstones of Trump’s economic agenda.

Unexpected though it may have been, Trump’s election has spurred optimism and firmer consumer and business data globally, raising growth expectations. The end result? A dramatic repricing of yields that has pushed equities and the Dollar higher.

While the bullish tone of risk markets makes sense, our advice would be to avoid overzealousness. A lot of optimism is now priced into markets, and the follow-through in policy and growth fundamentals will evolve slowly, leaving markets vulnerable to disappoint with periodic reality checks in 2017.

Policy follow-through is key

While Trump may be dominating the headlines and hearts of investors, the investment environment remains dominated by global policy concerns.

The macro backdrop is heavily dependent on global monetary and fiscal policy follow-through. Combined with the volatile political landscape, risk markets will be apt to wide swings around fair value.

The big picture is that the Fed has been cautious normalizing the interest rate environment, only raising rates twice in two years. And, looking forward, the December Fed meeting provided a projected path that is only slightly more aggressive than previous Fed forecasts. With these expectations now priced in, rates are fully valued and likely to drift down at the first sign of data or policy disappointment.

Factoring in the future

Taking these dynamics into account, we remain generally bullish, with data and sentiment supporting credit spreads into the first quarter.

Flexibility in fixed income will also be key throughout the year, as there are pockets of opportunity to tactically allocate across fixed income sectors. With the recent rise in short-term Treasury yields, suddenly the risk/reward characteristics for short-term fixed income investors looks very attractive.

Given the uncertainty around implementing the new administration’s policies, the market may have overshot the potential for substantially higher-rates. As the first half of 2017 progresses, look for fixed income performance to stabilize.

For more insight, please visit our Fixed Income Perspectives or reach out to the team at 512-895-4130.

Risk Management For All Seasons

Posted on August 24, 2016September 21, 2016 by Sage Advisory

Keys to Effectively Manage Risk Throughout a Market Cycle

Even as equity markets continue to make all-time highs, risk management remains one of the most important elements of the investment process. Coupled with the lasting impression of a former crisis – for today’s investor, the Global Financial Crisis – investors often make the mistake of treating all draw downs in risk assets as a crisis-sized event.

While data shows that there is a significant equity market downturn every 7-8 years on average, we often suffer from several smaller draw downs in the interim that are not cycle-ending bear markets. Preparing portfolios to weather these intra-cycle corrections, which are relatively modest market downturns of higher frequency, can be key to keeping clients on track.

A tactical approach to portfolio management coupled with adequate diversification can provide insulation from market fluctuations, while also offering risk mitigation in market draw downs, return enhancement in strong markets, and a smoother ride overall.

Here are three considerations for building an “all-weather” risk management strategy:

1. Portfolio protection strategies are not one-size-fits all.

According to our research, 80% of equity market draw downs greater than 5% are actually more intermediate in nature, ranging between 5% and 20%. During the large market corrections, when equities lose more than 20%, asset classes such as bonds, defensive commodities, and currencies have done the best job protecting investors.

However, there is no consistent pattern to protect investments during the smaller, intermediate downturns. For example, in periods where central banks are enacting tighter monetary policy, sovereign bond and equity prices could go down in tandem for some time, negating any diversification in an investor’s portfolio.

Portfolio protection during intra-cycle corrections will be related to economic conditions, policy response, and market sentiment at that specific point in time. A sound tactical approach will improve an investor’s probability of success in navigating periods of stress.

2. Going for cash may cost you. Diversify instead.

While the certainty of cash is appealing, especially during market corrections, investors often suffer the ill effects of being under-invested when markets bounce back after a downturn. Data shows that these intra-cycle downturns tend to happen fast and recover quickly, underscoring the importance of remaining invested. In our view, it’s better to temper risk while staying fully invested and adequately diversified.

One key to helping investors weather the storm is to maintain the proper mix of assets according to the investor’s risk tolerance and time horizon. This goes a long way towards mitigating portfolio volatility during periods of stress. Additionally, investors should have a portion of their allocation dedicated to a more tactical approach. Having the flexibility to tactically rotate, or even exit, market segments can add another layer of risk mitigation and help smooth out the ride over the long term.

3. Leverage the breadth of the ETF Universe.

ETFs provide a liquid and transparent vehicle to access global markets. With over 1,900 US listed ETFs spanning $3.8 trillion of assets under management, the investor now has unparalleled flexibility to construct a low cost, well balanced portfolio.

The ETF marketplace offers a tremendous amount of tools to protect portfolios. This includes more traditional risk off asset classes such as core fixed income, commodities, and currencies, along with efficient access to a variety of defensive sectors. Additionally, ETF Sponsors have launched low-volatility equity ETFs designed to provide diversified exposure to lower volatility US and international market segments.

Despite temptation to target risk management around only the largest market downturns, a well-rounded risk strategy will help you weather any storm.

For more detail, check out our Asset Allocation Perspectives video here.