by Brad Tank, Chief Investment OfficerâFixed Income, Neuberger Berman
The search for value is on, particularly in short to medium duration.
In a webinar a few weeks back, my colleagues, Joe Amato and Erik Knutzen, and I sought to size up the market environment of ongoing volatility and selloffs, pressure from the Federal Reserve, and fears about inflation and growth. Our view with respect to fixed income portfolio positioning was that, in the aftermath of a very difficult four months of rising rates and wider spreads, we were past the time when it made sense to have an extremely defensive view on both bond duration and credit. With recession talk entering into the conversation, and value in our view returning to fixed income in the form of yield, we believed it was appropriate for investors to focus on the prospect of two-way markets after extended directional moves.
Today, that idea remains on point. Notwithstanding the recent rallies in both rates and spreads, absolute yields in most credit markets remain at least double the levels that prevailed throughout much of 2020 and 2021.
Looking to Yield
At the end of the day, we believe yield translates into return potential, and itâs an opportune time to assess current yields in the context of the durability (or lack thereof) of the Fedâs recently aggressive monetary policy. Data has generally been mixed, as have policy signals from Fed personnel. And reasons for market movement have often been a bit arbitrary and likely based on thin data or one-off commentary, for example with the Treasury yield losing some 50 basis points when one Fed governor talked about a pause, only for investors to hear one week later that another Fed official anticipated no such pause, but rather continued rate increases.
Credit spreads have also been subject to flux. Back when Target and Walmart noted lower profit margins, spreads widened not only on cost worries, but on fears about the health of the consumer. Could the all-important U.S. consumer be rolling over? Subsequent data seemed to suggest she was not. At the same time, housing numbers have been suggesting weaknessâcould they indicate a pullback from extraordinary levels or something more sinister? We are seeing mixed signals on the economy, and mixed signals tend to translate into violent moves for credits spreads and risk assets generally.
Thatâs been our guiding principle lately. The moves could be sudden and severe, as the debates continue around duration and the intensity of the Fed tightening campaign, and the potential for a soft landing or recession. We remain in the no-recession camp, but we also donât see resolution one way or the other in the near future. Indeed, those who predict a contraction just keep pushing out the time horizon for that day of reckoning. Sometime in 2023 is their current reading, for what itâs worth.
Positioning
Itâs likely that the only way the debate gets resolved is if we actually get a recession. But investors have to do something with portfolios in the meantime. Fortunately, all this uncertainty lends itself to active trading and potentially capitalizing on readily apparent opportunities.
One reality is that the Fedâs hard move toward tightening, starting last November, has meaningfully flattened the yield curve, in our view creating ample risk/reward potential in shorter-duration bonds. Those who donât want to bear the full brunt of market risk can look to shorter high grade or high yield, and emerging markets, with a respectable total return profile.
We believe short-duration bond portfolios in both the high yield and emerging market debt sectors have the potential to provide yields north of the 6% level, or about 80% of that represented by the full market. High-grade short duration bond portfolios can potentially carry yields well within the 3% range. For individual investors, municipal bonds appear similarly attractive.
In essence, you have to engage the market that you have, and after a grim first several months of 2022, there is a good deal more to work with today.
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