Don’t burn the bridges to recovery

A widening US trade deficit, lower German factory orders and relatively flat Eurozone services PMI. The economic data is disappointing to say the least in supporting global growth expectations and subsequent investor risk-on sentiment.

Confidence in global growth remains weak following a fall in oil prices over the past few days on fears of oversupply and weak global demand, leaving investors with little to no sources of justified yielding securities given the volatility being experienced in financial markets. Yields on 10 year German government Bunds yesterday hit a 12 month low yielding as little as 0.081 percentage points, close to its all-time low of 0.073 percentage points. The flight to safe haven assets is custom when investors’ nerves tense up, justifying the lower yields (higher prices).

The UK is also experiencing turmoil of its own as sovereign bond spreads widened further yesterday as the June referendum on a Brexit vote approaches. Political factors in 2016 are certainly major players around the uncertainty of a global recovery. It seems likely that markets will decide an end to the wave of volatility present.

The recent Panama papers scandal will do little to improve the matter, although quantifying any effects this scandal may or will have on financial markets, if any, would be difficult. In fragile times such as these, consumer confidence is the pillar to a recovery. Global government officials implemented in scandals not only degrade themselves, but indirectly harm the GDP growth prospects of their respective countries. Foreign Investors are said to allocate capital efficiently, within a transparent and fair market and jurisdiction. Hence, scandals and corruption are triggers for investors to divert and invest funds elsewhere. With already little to few investment opportunities, the search for yield around all the dragging factors in the economy keeps getting harder.

Opportunities exist, when sourced correctly but fundamental analysis imperatively overrules technical analysis in volatile times. The recent dovish talks held in March by the US Federal Reserve and ECB allow risk-on investors to contribute allocation to Global Fixed Income.

Why?

Bonds are generally affected by interest rates and credit ratings. When interest rates are expected to stay low, bond prices (which are inversely related) are expected to remain stable or even increase. For instance, when high yield companies are able to borrow funds at lower rates of interest, risk-on investors see their default probabilities as lower and could arguably benefit from their attractive coupons relative to investment grade alternatives.

It is important to conduct the proper fundamental analysis prior to investing in high yield, principally looking out for an appropriate business model and then digging into credit metrics to determine the company’s soundness. Other than that, it is crucial that when analysed, companies are compared to their peers.

The coming quarters need to be monitored closely. Opportunities will present themselves, and markets will adjust around all influential factors affecting the economy. In the end, the advantage will go to active over passive investors, and even more to those properly timing their market entry and exit points.