Can European Bond Investors Rely on the American Dream?

12 December 2019

3 min read

This year has brought multiple challenges for world economies. So far, the US has continued to offer a stable investment environment, relatively robust growth and attractive yields. But after a decade of expansion, can the American dream stay viable for European bond investors?

In 2019, investors have faced continued market uncertainty around trade and de-globalization. Now, as global growth forecasts trend down, financial markets may finally be approaching a turning point. For investors, that means finding a way to keep the income flowing while also shielding their portfolios from the full effect of higher volatility and slower growth.

What Does 2020 Have in Store for the Markets?

We expect the global economy to grow by just 2.2% next year, the lowest in 10 years. That's not weak enough to be called a recession and it's certainly not comparable to 2009 (when global output contracted by 2%). But it does represent a very weak performance that could leave the world more vulnerable to adverse shocks. We are unconvinced that lower rates alone will be enough to reverse the slowdown.

Scenarios Which Could Promote Growth

Three channels could prompt better-than-expected growth next year:

an end to trade tension
surprisingly effective monetary policy and
a significant pro-active global fiscal boost.

We are skeptical on all three. For example, we see the trade war as a manifestation of two key secular trends—populism and geopolitical conflict between China and the West; so it can't be solved by a “tweet” or even the end of Donald Trump's presidency. And while we have long thought the burden of supporting growth and inflation would eventually shift to fiscal policy, we doubt the transition will be fast enough or broad enough to make a material difference to 2020 growth. Still, we'll be monitoring this and other factors carefully.

How Do European Investors Find Opportunity in US bond markets?

For euro-area investors, US bonds can provide important diversification benefits, particularly as the cost of hedging US dollars into euros is now modestly less punitive. We advocate a US bond strategy that balances the security of high quality government bonds with the income generation of higher yielding credit. Two things are critical in this environment:

the ability to tilt towards either side of the balance, depending on the market environment and
diversification and flexibility on each side.

Despite weaker forecasts, we still believe in a tilt towards growth assets, given our expectations for still positive but modest economic growth. And in the current environment, we think a US-based portfolio should be diversified across multiple sectors (Display):

High Yield Corporates

Over time delivers equity-like returns but with lower volatility

Investment-Grade Corporates

Over time delivers equity-like returns but with lower volatility

Securitized Assets

Residential mortgages give us exposure to a healthy US consumer while market dislocation leads to attractive yields in the commercial mortgage space

Emerging markets can be added as a diversifier that should benefit from atractive valuations and accomodative central banks in developed countries

Today, US companies face threats from factors as diverse as trade wars and increasing regulatory oversight. We think it makes sense for investors to focus their credit exposure on parts of the market better positioned to withstand these risks, for instance the US consumer or banking sectors.

What about interest-rate risk? In today's environment, we think there is a case for running with below-average duration to guard against future rate rises. But there is an even stronger argument to stay within an intermediate duration range in a balanced portfolio. Maintaining the balanced approach has proven more effective than trying to predict the next move in rates or credit.

For example, during 2019, investors with big duration underweights were wrong-footed by changes in the direction to US monetary policy. Many were caught off guard when the US Federal Reserve reversed its monetary policy and adopted a dovish stance following four hikes last year. To get the best results from a US bond portfolio, sticking to a balanced investment discipline is the most important consideration of all. However, flexibility on both sides of that balance is also critical. For example, it's important to shift credit exposure among different sectors to capture the most compelling opportunities just as it's also important to tweak duration exposure to capitalize on valuations. Still, by maintaining the right balance and structure, we think a portfolio of US bonds can produce worthwhile returns, while mitigating downside risks.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.

About the Author

Scott DiMaggio, CFA

Scott DiMaggio is a Senior Vice President, Head of Fixed Income and a member of the Operating Committee. As Head of Fixed Income, he is responsible for the management and strategic growth of AB’s fixed-income business and investment decisions across the department. DiMaggio has previously served as director of Global Fixed Income and continues to be a portfolio manager across numerous multi-sector and multi-currency strategies. Prior to joining AB’s Fixed Income portfolio-management team, he performed quantitative investment analysis, including asset-liability, asset-allocation, return attribution and risk analysis for the firm. Before joining the firm in 1999, DiMaggio was a risk management market analyst at Santander Investment Securities. He also held positions as a senior consultant at Ernst & Young and Andersen Consulting. DiMaggio holds a BS in business administration from the State University of New York, Albany, and an MS in finance from Baruch College. He is a member of the Global Association of Risk Professionals and a CFA charterholder. Location: New York

This is a marketing communication. This information is provided by AllianceBernstein (Luxembourg) S.à r.l. Société à responsabilité limitée, R.C.S. Luxembourg B 34 305, 2-4, rue Eugène Ruppert, L-2453 Luxembourg. Authorised in Luxembourg and regulated by the Commission de Surveillance du Secteur Financier (CSSF). It is provided for informational purposes only and does not constitute investment advice or an invitation to purchase any security or other investment. The views and opinions expressed are based on our internal forecasts and should not be relied upon as an indication of future market performance. The value of investments in any of the Funds can go down as well as up and investors may not get back the full amount invested. Past performance does not guarantee future results.

This information is directed at Professional Clients only and is not intended for public use.

Can European Bond Investors Rely on the American Dream?

What Does 2020 Have in Store for the Markets?

Scenarios Which Could Promote Growth

How Do European Investors Find Opportunity in US bond markets?

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