The past two weeks have seen dramatic rallies in high-yield bonds, mortgage-backed securities and other asset classes, as well as an increased intensity in a two-month long rally in US equities. With interest rates in America virtually at zero, cash is an increasingly less attractive place to park money. Have investors with cash to deploy already missed the great opportunities?
No, argues Robert Manning, CEO and CIO at MFS Investment Management in Boston, who argues that high-quality credit and emerging-market debt remain attractive asset classes on a risk-adjusted basis. That's because these rallies are going to be short-lived and the US economy is not going to enjoy growth any time soon. Therefore investors should stick with US companies with strong balance sheets, which can survive, and with sovereign debt from resource-rich emerging markets.
"The apocalypse has been averted but we're not returning to growth," Manning says. "With a good credit, at least you're getting paid."
In the US market, while a 10-year Treasury is currently yielding 3.2%, a triple-A rated corporate bond of the same or shorter tenor will provide 6%. Compounded over time, it will readily beat Treasuries or cash even if spreads don't come in further. "We're talking about companies like Pepsi that are not going to default," Manning says.
He is less comfortable with high yield because, in many cases, these companies must refinance debts, and if they can't, then there won't be any coupon for investors.
"We love emerging markets, that's the place to be over the next three to five years," Manning says, particularly those with commodity and energy resources. "Mexico has a better balance sheet than the United States," he notes, although he says MFS prefers sovereign EMD, not emerging-market credit, due to liquidity and governance concerns.
Although Manning says US policymakers over recent months have done an excellent job of bringing stability to the markets, he says the big concern is going to be inflation. "How does the Fed take all this liquidity out of the system once things recover?" he wonders. "It's put a base beneath the economy but it's expanded its balance sheet by a factor of 10." He says inflation-linked government bonds are attractive and should be added to portfolios at the margin. Other suggestions for investors: inflation will support markets with commodity plays, which includes many emerging markets as well as developed countries such as Canada and Australia.
Despite the headwinds, he thinks inflation could return sooner than many investors expect. "The balance sheets of Corporate USA are in good shape," Manning says. "Inventories are low and nothing has been spent on research or capex." This pent-up demand means that should things turn around, perhaps as early as next year, prices could snap back immediately, to meet a rush in demand.