Bond Market Backdrop Bolsters the Search for Value

By Dave MacEwen - October 12, 2017

Long-term bond investors have enjoyed an extended period of positive performance. And there are few reasons to expect any big changes in bond market fundamentals, at least in the near term. But along with this status quo backdrop comes a mounting challenge—finding value among bonds

Despite a handful of short-term disruptions over the last several years, bond market volatility has generally remained in check. As fundamentally driven, active investment managers, we welcome a certain degree of market volatility. Such movements typically cause yields to rise and credit spreads to widen, potentially creating opportunities to purchase securities at attractive valuations. However, in today’s market, yields remain relatively low, credit spreads continue to grind tighter, and value among bonds is becoming less apparent.

Where We Are Discovering Opportunities

We don’t expect this scenario to change much in the coming months, given our outlook for modest economic growth, muted inflation, and range-bound interest rates. Although this backdrop may make broad bond market value less obvious, it doesn’t eliminate it. Our research continues to uncover pockets of value and opportunity within two prominent sectors—corporate and securitized.

Among investment-grade corporates, we are uncovering attractive prospects within the energy sector’s midstream and pipeline industry. In particular, our credit research indicates valuations remain attractive, and financial measures have improved due to capital raises, improved liquidity and shareholder payout reductions. We also are finding attractive opportunities within the banking sector, where regulations mandating high capital levels are fostering strong balance sheets.

In the securitized sector, we are finding value among non-agency mortgage-backed securities, where select issuers are benefiting from improving housing market fundamentals, favorable technical factors, and attractive bond structures. In particular, the timeshare segment is improving due to upbeat consumer trends and stability in the lodging sector, while attractive supply/demand dynamics are aiding single-family rental securities.

We also are uncovering value and attractive risk/reward dynamics elsewhere:

  • TIPS: Market expectations for long-term inflation, as measured by the 10-year breakeven rate,1 remain below historic averages, which we believe indicates TIPS are attractively valued.
  • Global interest rates trade: We are finding opportunities to take advantage of wide spread differentials and a potential convergence of rates between the U.S. and the U.K. and Germany.
  • Currencies: We continue to find value by initiating long and short positions among select foreign currencies.

Staying True to Time-Tested Principles

Finding value amid challenging market conditions remains an important element of our active management approach. But as we seek opportunities to enhance performance, we also remain focused on investing in a diverse mix of high-quality securities offering attractive risk/reward potential. We believe this time-tested approach is prudent whether value is abundant or scarce.

Dave MacEwen
Dave MacEwen
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    Bond Market Backdrop Bolsters the Search for Value

    Long-term bond investors have enjoyed an extended period of positive performance. The challenge now? Finding value among bonds.

      1The 10-year breakeven rate is the yield difference between 10-year nominal Treasury notes and 10-year TIPS. Theoretically, it indicates the market’s expectations for inflation for the next 10 years and reflects the inflation rate required for TIPS to outperform nominal Treasuries during that period.

      Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.