James Gard: We're here at the Morningstar Investment Conference. With me is Iain Stealey. He is the International CIO for Fixed Income at J.P. Morgan Asset Management.
Welcome Ian.
Iain Stealey: Thanks for having me.
Gard: So, on stage you mentioned some good news for bond investors. One is that central banks are nearing the end game in terms of rate rises. The other is real yields are attractive for first time in years. And the other piece of good news is that corporates are coming into a recession in good health. In terms of the opportunity set that you're looking at, where are the most attractive opportunities?
Stealey: I think, as you mentioned, this is the first time really in 15 years that we've seen attractive real yields. We do think the central banks have done an awful lot of tightening. There might be a little bit more to come, but we're definitely towards the end of this period of moving rates higher, which means the next move is likely to be lower bond yields over the medium term, which means high-quality fixed income is attractive. So, the areas that we like at the moment, agency mortgages in the U.S., which have been hit by some technical factors, as we've had to reduce some of the regional bank balance sheets, and also high-quality credit, as you mentioned, corporates looking in pretty good health at the moment. So, having duration with a little bit of extra yield, but being up in quality makes a lot of sense to us.
Gard: Sure. What about emerging markets? There's always volatility in that area, but you said that yields are very attractive in certain aspects of the market there.
Stealey: Yeah, particularly in the local emerging markets. So, the emerging markets central banks were very early to the hiking cycle. They've raised rates a lot. We're starting to see inflation come back down again across the emerging economies. And what that has left us with is pretty attractive real yields. And if you think some of the developed market real yields are attractive, you're getting even more value in the emerging markets. Now, as you said, there's always a bit of uncertainty and a bit of volatility with emerging markets. So, you probably do need a bit more yield. But I think you are being adequately compensated at the moment. And when you look at some of the places like Brazil, places like Mexico, those real yields are really, really quite compelling.
Gard: Sure. So, in your speech, you mentioned potential risk to this improving scenario. One is, you're concerned about the risk of corporate defaults and you're saying that the markets perhaps aren't pricing in the real risk of defaults.
Stealey: I think so. I think what we've seen over the course of this year is that the high-yield market has done very well, not so much in spread tightening but at least you've clipped your pretty attractive yield on offer. But when we look at it, we don't really think it's compensating you for a slowing environment. We do believe that over the next, call it, nine months or so we're likely to see the global economy slip back towards recession or at least have the market price one, which means that the minute you're looking at high-yield spreads that are below long run averages, you're not really being compensated.
I think there was an argument to own the high-yield market over the last few years because there was not really an alternative, core yields were very low, high-quality yields were very low because of what the central banks were doing, some people were going to the high-yield space for additional yield. You don't really need to do that anymore. You can get high-quality fixed income at really attractive yields, I'd say, 5% to 6% in the high-quality investment grade corporate markets. I think that's a better alternative as we start to go towards a slowing economy.
Gard: Sure. That makes sense. I mean, in terms of wrap up, you said last year was horrible and this year is one of the best conditions for the last 15 years. Is it difficult to be a fund manager when suddenly everyone is talking about bonds, everyone is obsessed with bonds, everyone wants to own them for yield. Is there – you'd have to deal with being in the limelight now or something?
Stealey: I think it's a good environment to be in because obviously people want to talk about bonds again. I think the concern out there, of course, is that people weren't used to the losses that they saw last year. So, it's very fresh in their memories. And I think also a lot of people are questioning are we actually at the end of the hiking cycle. And it's difficult to make a definitive decision on that because we are still seeing inflation which is being stubbornly high, and the central banks have been very vocal that their number priority is bringing inflation down. So, it could be that we see a couple of more hikes. But I'd say I think the more longer-term view with a medium to long-term horizon is that bond yields do look really attractive at the moment. And it is the best opportunity we've really seen to go into core fixed income for the last 15 years or so.
Gard: Sure. Yeah, thanks. So, in terms of the mix between what bonds are supposed to do for your portfolio, do they still have that same core function even after the volatility over the last few years?
Stealey: Yeah, and that's one of the real benefits actually of fixed income now relative to last year is they are starting to exhibit those properties that they should be exhibiting. So, last year, we had what I would call wrong way correlation. So, they weren't providing you support when risk markets were selling off. And that was because risk markets were selling off on the back of central banks tightening policy and yields going higher. But what we've really seen, particularly since the regional banking situation in the U.S., is that yields are now at a level where they are high enough that if you have big growth concerns, the expectation is that the central banks will be able to react to it and that means yields go lower and they do give you that ballast. And what's really nice is that over the last, on sort of a rolling three-month basis, we've started to see that bond-equity correlation go back to negative. And that's really what an asset allocator should be looking for.
Gard: Sure. Excellent. Well, thanks very much for your time today, Iain. For Morningstar, I've been James Gard.
