It’s easy to be worried about investment risk right now. China, the world’s second largest economy, is experiencing growing pains that have sent oil and other commodity prices tumbling. China’s attempts to transition from an economy built on government infrastructure spending to one built on consumer spending is going to be tricky. Meanwhile, Japan and parts of Europe are employing negative interest rates in a bid to boost their economies, a move critics speculate could backfire. The U.S. economy continues to move forward, but neither so fast nor so slow that anyone is certain what the Federal Reserve will do next on monetary policy. The UK will vote in June on whether to exit the European Union, the U.S. is barreling toward another potentially divisive presidential election, and geopolitical risks of all sorts remain a constant.
“Overall, the global economy is still plagued by sluggish, modest, weak growth,” said Tom Girard, senior managing director and head of fixed income investors for New York Life Investors, during a talk at the 2016 SVIA Spring Seminar. “We have relatively low inflation, and in fact deflation in some parts of the globe. We continue to see central banks looking to provide ways to support the economy, all leading to bouts of dramatic volatility in the financial markets. I’m not a central banker, but if I was, I think I would come out of one of [their] meetings and hold up my hands and yell for help.”
The help Girard has in mind, he said, would include regulatory and tax reforms addressing issues such as social programs, entitlement spending and immigration.
For all that, Girard argued that the outlook for fixed-income investors isn’t as bad as it might seem. The International Monetary Fund continues to forecast that the U.S. and the world economy will avoid recession in 2016, he noted, with the U.S. economy growing at perhaps a 2.5 percent rate, or a bit above what it did in 2015.
“The U.S. is the most stable economy right now around the globe,” Girard said, adding that he considers it halfway between mid-cycle and late stage. That would put it several years from another recession. “I know there’s frustration with the strength of the recovery, but you can’t argue with the durability of it,” he said. “We’re going into the seventh year of economic expansion, the third longest in the post-World War II era.”
Girard attributed the strength of the U.S. economy in large part to the health of the labor market, which he said has performed “remarkably well” since the financial crisis. Over that time, it has generated more than 12 million jobs, which has sent the unemployment rate down from a peak of 10 percent to 5 percent, a figure likely to move lower through the balance of 2016. Girard said consumers are feeling pretty good about their household net worth, which is at an all-time high, and about the recovery in the housing market, which has sent home prices in many parts of the country back to pre-crisis levels. At the same time, he said, consumer debt-service payments are at their lowest levels in 30 years, and low oil prices are putting more spending money in consumer pockets. U.S. inflation has remained modest throughout the recovery, and Girard said his firm’s forecast is for inflation to remain “relatively well-behaved,” allowing the Fed to continue to be patient in raising interest rates.
Against that backdrop, Girard said fixed-income managers, including stable value managers, have a number of attractive investment opportunities available to them. He said he “wouldn’t be looking to take a lot of interest-rate risk right now,” and would focus on the two-year-to-five-year part of the yield curve.
“Where we’re most comfortable taking risk has to do with asset allocation,” he continued. He said he saw opportunities in corporate bonds, where valuations still looked attractive on a historic basis. Among the best-positioned sectors, he said, were financials, including insurance companies, large U.S. banks, some Canadian banks and select European banks. He also mentioned industrials, including energy, where he said some relatively solid credits have been sold off over the past two years as oil prices have plunged. Still, he stressed that security selection will be critical throughout the corporate sector. “We don’t think valuations are so cheap that it’s a sector play where you can just allocate to the sector and forget about it,” he said. For stable value portfolios, Girard said, commercial mortgage-backed securities offered “reasonably attractive” valuations and “pretty healthy” fundamentals. He said AAA-rated paper and asset-backed securities in the two-to five-year portion of the yield curve also looked attractive. He urged investors to be cautious in the mortgage-backed securities sector, but observed that opportunities might occasionally present themselves there during periods of market volatility.
“In spite of all the risks and uncertainty out there,” he summarized, “I think you’re looking at a situation where you’re going to get more of the same from the economy, with modest to sluggish growth. You’re probably still going to get relatively tame inflation, and central banks will still be playing a significant role in terms of trying to help economies. I think for stable value portfolios it’s going to be about yield, and taking advantage of volatility in the market—finding those pockets of attractiveness and putting yield into the portfolio to create some outperformance for clients.”
