Companies will not benefit equally from a recovery, making credit selection essential in picking the winners
When financial markets woke up to
the coronavirus pandemic’s likely
level of contagion in early 2020,
there was a disorderly flight to
safety. Fortunately, though, the huge
international policy response that
followed restored confidence and
markets rebounded.
From peak to trough the FTSE Global
Equity Index Series was down more
than 20% early in 2020.1 Bond
markets were hit, too, as high yield
and investment-grade bonds were
initially sold off. Indeed, the months
of March and April 2020 were noted
for their massive redemptions of both
high yield (HY) and investment-grade
(IG) mutual funds.
But just as the sell-off was both
rapid and deep, so too the policy
response was unprecedented.
Globally, central banks pumped
around US$6 trillion into the economy
via quantitative easing in 2020.2
Some central banks, such as the
US Federal Reserve, also expanded
their toolkit, purchasing corporate
bonds for the first time.3 Meanwhile
the fiscal response worldwide
has been historic in proportions,
with governments in many cases furloughing salaries of employees,
as well as providing tax breaks and
state guarantees of lending.
With 2021 well underway, bond
markets are now past the distress
stage and, with stimulus ongoing,
are well on the road to recovery.
The huge stimulus ensured that
almost all fixed income asset
classes recorded respectable returns
in 2020: many bond yields hit all-time
lows while the amount of negativeyielding
bonds hit all-time highs.
IG bonds also did well: global returns
for 2020 as a whole were 7.7%.4
Credit selection will be key
But what about 2021? It is clear
that an aggressive roll out of
vaccines is required before the
global economy can return to an
environment resembling “normal”.
In the meantime, economies will
remain reliant on stimulus measures
to get the recovery up to speed.
In the short to medium term, at
least, there are few signs that central
banks are easing off the gas. Indeed,
we expect them to continue injecting
substantial liquidity throughout 2021.
Major central banks such as the
European Central Bank and the US
Federal Reserve have also called
for more fiscal measures to aid
economic recovery. In the US, we
think there is a strong likelihood of
additional large-scale fiscal stimulus
under President Joe Biden.
Clearly, bond markets are recovering.
But that recovery will be unequal,
and some sectors and companies
will fare better than others. In such
challenging markets, credit selection
will be key. This plays into our
strengths at Columbia Threadneedle
Investments, given our 150-strong
global fixed income team5 covering
research, portfolio management and
trading. We are bottom-up investors,
calling upon fundamental research
from a global team of in-house
credit analysts.
As we enter 2021, we expect most
IG bonds to weather the storm of
Covid-19, despite record levels of
corporate debt. Following significant
debt issuance in primary markets
in 2020, most IG companies have
ample liquidity should unexpected pandemic-related downside risks
materialise, which impede the
expected global recovery.
In addition, management teams at
many companies are now looking to
deleverage their balance sheets by
paying down debt. On our forwardlooking
models we see leverage
coming down in 2021 and, over
the course of the year, corporate
leverage broadly returning to levels
last seen at the end of 2019 – a
major achievement given the damage
inflicted to global economies by the
Covid-19 pandemic.
Nevertheless, we are keeping a close
lookout for warning signs – such as
share buybacks, M&A or dividend
increases – that management teams
are being distracted from such debt
reduction plans.
Stimulus is here to stay
What other potential headwinds are
there? Perhaps the biggest risk to
bond markets is inflation. We have
seen slight upticks in prices but, so
far, nothing to give us major concern. Longer term, we are comforted
by the fact that global economies
face powerful structural downward
pressure on prices, given deflationary
phenomena such as technological
advances and ageing demographics.
The withdrawal of stimulus is another
worry for fixed income investors,
given the huge support global
policy responses have bestowed on
bond – and equity – markets. A fast
and effective programme of global
vaccine roll-outs could set the stage
for a strong economic rebound,
reducing the need for policy support.
But even in such a rosy scenario,
we believe stimulus measures are
here to stay, at least for the short to
medium term. That means they are
likely to provide support for global
bond markets into 2021 and beyond.
