Bonds can solve a problem or create one, according to Paul Matlack, senior vice president, senior portfolio manager and fixed income strategist for Delaware Funds Macquarie Investment Management. “The days of making equity-like money out of bonds [are] gone,” Matlack said during a session at the Envestnet Advisor Summit on Thursday.
We’re still in an expansion phase, he noted, but economic soft data is much better than hard data.
The issue in the U.S. economy is excess labor, he added. “There’s a lot of labor sitting out this expansion, so that’s why wage rates have not really clicked up dramatically.”
The big growth driver, consumer spending, has been low as a result. Combined with flat corporate and government spending, the low-growth economy has persisted.
Bank lending is down as well, according to Matlack. “You’d think after eight years of expansion, you’d see loan losses clicking up, but no,” he said. The most recent quarterly reports from big banks have shown they’re releasing reserves back into their earnings, he said. “That tells me they’re not lending with the aggressiveness you would expect.”
Investor focus has shifted from the Fed to Congress and the president, which has made the Fed more comfortable increasing rates. Matlack expects the Fed will raise rates again in June, “and thereafter it’s going to be very data-dependent.”
He doesn’t see growth taking off unless the government can make some aggressive stimulus moves.
The economy is at an inflection point, Matlack said, “and you need the ability to move around. You need the ability to either get aggressive or get defensive, and it’s hard to say which way we’re going.”
Brian Pytlewski, senior vice president and director of municipal fixed income for RNC Genter Capital Management, had a mixed view of the interest rate environment.
On the plus side, municipal credit quality is very stable, he said. Last year, the S&P had just 1,800 rating actions, compared with 4,000 in 2009.
Ratios of bonds versus Treasuries are very attractive, according to Pytlewski, with Treasuries between 77% and 104%. ”Historically speaking, that’s a very attractive rate,” he said.
The Trump administration has been supportive of infrastructure upgrades, although the Treasury secretary has said health care and tax reform will be bigger goals, according to Pytlewski.
“What that tells me, and what that should tell you, is that traditional public finances are going to be a big part of getting this done.”
The impact of Puerto Rico’s bankruptcy should be fairly isolated, according to Pytlewski, although some clients may have some exposure that needs to be addressed. Puerto Rico declared bankruptcy with $52 billion in debt; by comparison, Detroit declared bankruptcy with $8 billion in debt.
Pension and OPEB liabilities are a drag on bond performance, according to Pytlewski. Furthermore, pension holders have been “regarded as sacrosanct” at bondholders’ expense, he said.
Jason Vassil, senior portfolio strategist at Deutsche Asset Management, noted it’s hard to make assumptions about interest rates because the current environment is so different from the past.
Vassil warned against listening to predictions about interest rates. Since 1981, economist predictions in the Livingston Survey have been wrong about the direction of interest rates about 95% of the time, he said.
Even small moves can impact portfolios in a big way when rates are low, Vassil said. He recommended the European high-yield market as an opportunity for clients.
“Everyone says, ‘I can’t invest in European high-yield; it’s too risky and the client doesn’t get it,’” but Vassil noted it has higher average credit quality than U.S, and the sector is up 23%.
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