Fixed Income Market Fears are Overdone, Western Asset Management Deputy CIO Declares
OREANDA-NEWS. February 19, 2016. In a webcast surveying global fixed income markets, Western Asset Management Co. Deputy Chief Investment Officer Michael C. Buchanan said that while investors may be nervous, they should be looking for opportunities amidst the noise.
"There's a lot of fear in the market, on a macro scale," Mr. Buchanan observed. "We understand those fears; we're cognizant of those fears; however, we do think those fears are overdone."
"Both Europe and the U.S. can maintain a slow, but positive growth trajectory," he continued. "China will engineer a soft landing, and the backdrop from central banks is accommodative. Even as the [U.S. Federal Reserve] is removing accommodation, we still think they're very engaged and have accommodative tools they could use if need be."
The Western Asset team foresees specific opportunity in credit sectors.
"Credit valuations are disconnected," Mr. Buchanan said. "There's a big disparity between where current valuations are versus fundamentals. Most importantly, there's a real opportunity for our clients and investors to take advantage of credit markets right now in many different forms."
"Excessive fear and pessimism have weighed heavily on valuations. Although the concerns in the market are certainly valid and need to be assessed, we ultimately define value as the disparity between valuations versus fundamentals that favors our clients. It's very compelling. Despite a rough start to the year, we think 2016 will end up being a very good year for credit investors."
But investors had best move soon, Mr. Buchanan warned, because "spread tightening is very likely between now and year-end."
Mr. Buchanan discussed the macroeconomic factors likely to impact global bond markets.
"I tried to take the most topical ones ailing the market right now," he said. "First and foremost, China. It really relates to just growth, but more recently everyone's concerned about rapidly depleting currency reserves and the Yuan devaluation. We think these fears are overdone."
"It's interesting that so many markets are correlated directly with crude oil now. Look at the spectacular fall in crude oil since June 2014 and you understand the price reaction, in particular in high yield, where about 15 percent of the market is engaged within energy. The market is clearly pricing in excessive defaults within that space. It's not just the Fed that's tightening."
"The real fear is you take all these concerns and what it means to investors – or the anxiety in the market – is there's an increasing fear of global recession. It's understandable if you look at the International Monetary Fund ("IMF") estimates for world economic growth. They continue to be revised lower. The closer and closer we get to no growth, obviously that concern of recession is very valid."
However Mr. Buchanan concluded, "Not ignoring the risks that are out there, but when we put it all together, we see a macro backdrop that suggests the global economy is not going to fall into a recession. For reasons, first and foremost, the U.S. is on-track for positive albeit slow growth."
As for Western Asset's view on oil, Mr. Buchanan reported, "There is still a supply overhang of crude oil. When you look at inventory, it's a pretty daunting number; however, the dynamics that ultimately drive the price of oil are beginning to tell us you should expect to see some balance or harmony between supply and demand towards the end of 2016, perhaps early 2017. Prices will respond. We think we're going to see that as early as mid-year."
An expert on liquidity in bond markets, Mr. Buchanan was asked for his thoughts in Q&A.
"I wish I could tell you liquidity has improved in 2016," he said. "It hasn't. There is a positive byproduct that comes from less liquid markets, and that is the illiquidity premium we're getting paid to invest in corporate credit. That has expanded dramatically. While it's frustrating to witness markets that are less liquid, more volatile, the flip side is that investors are benefitting – especially buy-and-hold, longer-term investors through that elevated illiquidity premium."
"This lack of liquidity, it's not something that snuck up on us. We've been talking about it since 2009, 2010, and we're factoring that into how we manage portfolios in a thoughtful way."
Asked "where are we in the credit cycle?" Mr. Buchanan answered, "This credit cycle is unique in terms of its longevity. Because of the severity of the 2008 crisis, it is causing a prolonged cycle. Whether you're a CFO, CEO, Treasurer, you're not engaging in the kinds of risk-taking behaviors or activities that you typically would this far into a cycle."
"Credit cycles don't merely die of old age. They don't die of fear. They die because of fundamentals. The internal organs of a credit cycle, the fundamentals, those begin to deteriorate. We're not seeing that right now. It will happen. The credit cycle isn't broken. We will see another cycle, but I think for calls for the imminent demise of the credit cycle are premature."
"There's a supportive backdrop right now for credit, and we think this cycle still has legs."
Mr. Buchanan also projected optimism on the strength of U.S. and global banking system.
"U.S. banks are ahead of the game globally versus European financials," he reported. "That's probably not a unique thought. Look at what the market's telling us through equity pricing and you'll generally see that: U.S. banks have held up better in the sell-off than European banks."
"The risk of a new financial crisis, where banks are at the epicenter, is a very low probability. Even in some of the more vulnerable banks, there has been significant fundamental improvement. The capital system ... is in better shape than we were 6 or 7 years ago."
He also was asked what actual default rates in energy and high yield will be in 2016?
"Our point is that the market implied defaults are excessive," Mr. Buchanan said. "Default rates are going to go higher, from abnormally low levels, but we think they're going to stay below or maybe reach over the next year historical averages: call it 4, maybe a little north of 4 percent."
"We've already seen some of that in 2015. We think we'll see much more in 2016. These defaults are going to be concentrated, but nowhere near what is being priced into the market."
"The market is telling us 70 percent. So 7 out of 10 companies in the energy space are going to default over the next 5 years? We think it's going to be less, well below less than half of that."
About Michael C. Buchanan CFA
The Deputy Chief Investment Officer of Western Asset Management Co., Mike Buchanan is a specialist in high yield, having headed the Global Credit team. Prior to joining the firm in 2005, Mr. Buchanan served as Managing Director and Head of U.S. Credit Products at Credit Suisse Asset Management, and as Executive Vice President and Portfolio Manager at Janus Capital Management. He also worked at BlackRock Financial Management as a managing director and portfolio manager, and at Conseco Capital Management as a vice president and portfolio manager. A Certified Financial Analyst, Mr. Buchanan earned his B.A. from Brown University.
About Western Asset Management Co.
Western Asset Management Co. is one of the world's leading fixed-income managers with \\$433.7 billion in assets under management as of Dec. 31, 2015. The firm is a wholly owned, independently operated subsidiary of Legg Mason, Inc. From offices in Pasadena, Hong Kong, London, Melbourne, New York, S?o Paulo, Singapore, Tokyo and Dubai, the company provides investment services for a wide variety of global clients, across an equally wide variety of mandates. To learn more about Western Asset, please visit www.westernasset.com.
About Legg Mason
Legg Mason is a global asset management firm with \\$651.5 billion in assets under management as of January 31, 2016. The Company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
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