- Third-quarter returns driven by price appreciation as global search for yield intensifies
- Default rates slightly exceed long-term average; commodity-centric sectors weakest
- Low level of global interest rates continues to support higher-yielding asset classes
The global reach for yield intensified in the third quarter. The Bank of Japan continued its quantitative easing program, with the most recent iteration providing for outright yield caps of 0.0% on 10-year Japan Government Bonds; the Federal Reserve held interest rates steady while noting continued strength in the underlying U.S. economy; and European sovereign interest rates remain negative to nearly zero. With the stabilization in commodity prices and the abundance of low global rates, investors have resumed allocating to higher-yielding assets, as shown in the flow of funds charts below.
This inflow of assets has resulted in strong returns for opportunistic asset classes. However, the upcoming U.S. elections, December’s Federal Open Market Committee meeting, and ongoing uncertainty around oil prices may induce material market volatility.
Although default rates are slightly ahead of the long-term average, we expect that accommodative credit market conditions will keep a lid on the level of defaults. Moody’s expects the commodity-centric sectors to have the highest default rates in the coming year, with the metals/mining and oil/gas sectors predicted to peak at nearly 7.6% and 5.2%, respectively. Moody’s also predicts that the aggregate default rate 12 months from now will be 3.3% (down from the August 2016 level of 4.8%). Therefore, excluding the commodity-related sectors, default rates are expected to remain well below the long-term average, while the amount of risk compensation paid remains relatively elevated for both the U.S. high yield and emerging market high yield asset classes.
Given the continued expectations of limited Federal Reserve tightening, the proliferation of negative global interest rates, and subdued corporate earnings growth, we believe high-income-generating assets remain very attractive.
All returns cited are in USD. Index returns include the reinvestment of dividends.
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Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.
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There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems, than developed markets.
Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.
There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT) and taxable gains are also possible. Investments in below-investment-grade debt securities which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securitiesof a higher-quality rating.
Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging markets bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
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The Standard & Poor’s (S&P) 500 Index represents 500 large U.S. companies. The comparative market index is not directly investable and is not adjusted to reflect expenses that the SEC requires to be reflected in the fund’s performance.
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Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.
The Barclays U.S. Corporate High-Yield Index covers the U.S.-dollar-denominated, non-investment-grade, fixed-rate, taxable corporate bond market and includes securities with ratings by Moody’s, Fitch, and S&P of Ba1/BB+/BB+ or below.
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MSCI EM Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. Net total return indexes reinvest dividends after the deduction of withholding taxes, using (for international indexes) a tax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties.
MSCI EM Asia Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance in the Asian emerging markets. Net total return indexes reinvest dividends after the deduction of withholding taxes, using (for international indexes) a tax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties.
The MSCI EM EMEA (Europe, Middle East, and Africa) Index is a free-float‐adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of Europe, the Middle East, & Africa. The MSCI EM EMEA Index consists of the following 10 emerging market country indexes: Czech Republic, Greece, Hungary, Poland, Russia, Turkey, Egypt, South Africa, Qatar, and United Arab Emirates.
The MSCI Emerging Markets Latin America Index is a free-float‐adjusted market capitalization weighted index that is designed to measure the equity market performance of emerging markets in Latin America. The MSCI EM Latin America Index consists of the following five emerging market country indexes: Brazil, Chile, Colombia, Mexico, and Peru.
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