Despite a volatile start to the year and a brief Brexit-related setback, risk assets like high-yield bonds, convertibles and equities have continued their upward climb. Doug Forsyth details the multiple factors fuelling their strong performance.
For some time, many investors have been gravitating toward riskier assets to take advantage of attractive valuations and compelling total-return profiles – and some of the greatest beneficiaries of this shift have been high-yield bonds, convertibles and equities. Indeed, after a volatile start to 2016, risk assets such as these have turned dramatically higher, despite experiencing a brief Brexit-related setback in June. For example, on a year-to-date basis through August, US large-cap growth stocks moved up by 5.6 per cent, US convertible bonds returned 7.0 per cent and US high-yield bonds climbed 14.6 per cent.
One of the biggest factors boosting the performance of these asset classes has been investors’ search for income. Yields are depressed globally and have even turned negative for government bonds in Japan and developed countries throughout Europe; in comparison, the US high-yield market in particular offers a compelling yield advantage.
An improved fundamental backdrop has also been a driver of this performance. Second-quarter earnings were generally better than expected, and outlooks for the remainder of the year are largely positive, as the headwinds experienced in 2015 from the energy sector and from the stronger US dollar have begun to diminish. Companies should continue to benefit from stable and accelerating revenues, cost controls, and earnings growth and stability.
Another benefit to high-yield and convertibles is the modest forecast for defaults: While defaults are expected to continue to increase slightly, they should remain at a low percentage level for 2016.
All told, while the path for high-yield bonds, convertibles and equities may be choppy, and may at times require strong conviction, these asset classes still offer compelling yields and attractive total-return potential in a low-yield world. In our view, investors would be wise to add to their positions by taking advantage of lower prices when they present themselves.
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