Morningstar's "Perspectives" series features investment insights from third-party contributors. Here is Ariel Bezalel, manager of the Jupiter Strategic Bond Fund, on why he believes rising concern over high debt levels, weak commodity prices and other deflationary forces may put a ceiling on economic growth and inflation for some time to come.
We had been pessimistic about the prospects for global growth for some time prior to yesterday’s sharp sell-off across global equity markets. The sudden deterioration of a range of leading indicators last week, coupled with another leg-down in prices of global commodities, appears to have been taken by the market as an indication that global economic activity is weakening further, led by China.
Market sentiment, already jittery ahead of a possible September rate rise by the US Federal Reserve, was chilled further by China’s yuan devaluation two weeks ago, leading to emerging market currencies and assets once again being crushed, with many already at record lows against the dollar.
Since the sharp falls in China’s domestic equity markets on Monday, volatility has soared, while yields on ‘haven’ assets such as long-dated US treasuries and German bunds pushed lower as investors flocked out of riskier assets.
For some months, we have retained an above-consensus average duration of five years in the portfolio as we believe that high debt levels, weak commodity prices and other deflationary forces in the global economy are likely to put a ceiling on economic growth and inflation. As a result, the funds have so far benefited from investors’ flight to safety this week. In addition, the ‘barbell’ strategy we adopted in late 2014, balancing our position in longer-dated, Australian government bonds with a selective allocation to high yield, is designed to help the fund withstand volatility in global markets.
More recently we have been buying long dated US treasuries and also bought some 2 year US Treasuries with the view that a rate rise from the Federal Reserve is currently unlikely. So far this year, this balanced position has acted as a natural hedge, allowing us to take advantage in times of ‘risk-on’ sentiment while mitigating the risk of capital loss in moments of stress.
In credit, our bearish view on commodities means we currently favour European high yield over the US due to the latter’s large energy exposure, a position which has paid off in recent months as shale producers have come under increasing pressure from the collapse in global oil prices.
What Next for the Oil Price?
We do not think a sustained recovery in the oil price is likely in the near term. Oil could head a lot lower from here with all the excess supply out there and big questions over the strength of global demand remain. OPEC is refusing to cut production in an attempt to maintain control of the market, and we think US shale players are likely to bring production back on stream quickly if the oil price moves upwards, putting a cap on material near-term price increases. In our view, the pace and scope of innovation taking place in fracking technology continues to surprise to the upside, and the costs for shale projects in the US are coming down rapidly as producers scramble to make the maths work at lower oil prices.
While a political shock in the Middle East could cause oil prices to spike, additional supply from Iran has yet to come on stream and this could put further downward pressure on oil prices in the medium to long term and in turn put further downward pressure on inflation indicators globally.
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