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(Runtime: 6 min, 54 sec; size: 3.38 MB)
Jean Gauthier. I’m the chief investment officer for global fixed income for CIBC Asset Management.
Bonds are really important in a global portfolio. But first of all if you think of bonds versus equity and the other assets, bonds will always be a safe haven when it comes time to—for example in Q4 2018, when you have pressure on the risky assets, bonds will definitely protect you.
And on top of that, if you have a bond portfolio, a lot of the time in Q4 2018, when we saw pressure on corporate spread, a lot of people, there was a lot of the big advisors out there, like we said, BBB corporate bonds are going to be a big problem going forward. But if you have a diversified bond portfolio like a core or core plus strategy, where you have 30 to 40% corporate bonds—yes the corporate and the spread did go wider, that put a little bit of negative spin on the portfolio. But the rest of the portfolio is going to be basically provincial and Canadian bonds. And as those bonds have been rallying, they basically protect you for the spread, in the widening of spread of the created portfolio.
So to give you an example, in Q4 2018, even though corporate spread widened out by almost 60 basis points, still if you have a core plus portfolio you would probably return something like 1.25% for the Q4 2018. So a well-diversified bond portfolio, it’s a big asset. On top of that, when the corporate spread rallied in Q1 2018, the same core plus portfolio will definitely outperform. In that regard, in Q1 2019, [it] returned 4.4% for the core plus portfolio owner.
So definitely the diversification of the portfolio makes a big difference. If you take only one single asset class, and you think that you should sell all your bonds because there’s going to be pressure on corporate spread, I think it’s misleading a little bit. So you always have to be careful about that. At this point we still believe that recession is going to be something of a 2020 story, we don’t expect it for 2019. So having some corporate bonds in a portfolio remains a great asset.
On top of that, if you only have a corporate bond portfolio, I would recommend that you probably go with something like a short bond fund that will protect you if really there starts to be weakening in the economy—more weakening, because we have seen a little bit of soft batch since Q4 of last year. Then you would be protected because the short part of the curve will definitely outperform the rest of the bond curve and rally from here. So definitely having some corporate bond portfolio with a bit of short duration, I think it’s a great strategy right now.
Yes, it’s pretty interesting because I must have read, probably 60 or 70 different papers from economists around the world who have their own interpretation of the inversion of the yield curve. We had that both in Canada and the U.S. Definitely we are late cycle in terms of the economic cycle, which can produce those kinds of yield curve movements. But again, all the yield curve is telling you right now is they expect the central bank, at one point, to ease enough to keep the cycle going.
We went inverted only for five or six days, and normally you need at least probably 15 to 20 days being inverted to start to have a feeling about if we’re really going to go into a recession. And even that empirical study told us that when we have this kind of inversion of the yield curve, we should expect a recession between four and 14 months. So it’s really tough to gauge exactly when the next recession is going to be. But one thing we are sure is that we do acknowledge that we are late cycle, that we probably expect a recession probably in 2020 when the tax stimulus that we had in the U.S. since the last almost year and a half, is gonna be almost out.
So we do believe that economic growth is going to slow down, but again what’s gonna be interesting this time around is after the 2007/08 event, we saw a big intervention by the central bank with a lot of quantitative easing. The yield curve twists, and then major stimulus because they cut rates massively. So are we going to have again central bank really aggressive the next time around we’re going to have a recession? Which means that if it’s the case, we should not expect a long recession, and we should have a lot of intervention by the central bank.
Which is also one of the things that we have been seeing with the yield curve inverting—basically the market is telling you that the market, the global economy, is slowing down a little bit. We’re seeing soft patch here and there, and basically the market is telling central bank, “You should be acknowledging that, and be ready to cut rates.” And it’s basically what we have been seeing, both the Federal Reserve, the ECB and the Bank of Canada all came out with more dovish statements about the economy over the last probably six to eight weeks, which produced the inversion of the yield curve—and … the market stabilized at this point.
I think investors should just realize that it’s maybe not time to be full risky assets, maybe pare down a little bit on risky assets. Maybe a bit more overweight in fixed income, maybe overweight in the short part of the curve. And again, still we do not see a 2007 and 2008 situation—we see just a normal recession which can probably slow down the market. But again, companies should continue to make money, which means a strategy of probably long corporate bond, and a little bit of long in the short part of the curve. Just because if something happened [and the] central bank cut, the short part of the curve will protect you. So again, being a little bit diversified remains the name of the game for the time being.