Despite an uncertain market landscape impacted by geopolitical volatility, institutional investors are staying the course with portfolio management, says Andrew Norelli, managing director and member of the global fixed income, currency and commodities group at J.P. Morgan Asset Management.
“Even in the depths of the biggest risk-off flare-up that we had back in March, we didn’t really see any folks trying to sell public high yield or loans or [collateralized loan obligations] because they felt stuck in private credit.”
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Instead, investors are taking in a market with equities at all-time highs and record tightening of credit spreads. Distress from overleveraged software businesses hasn’t become a significant concern for investing markets, according to Norelli.
“The thing that’s caught a lot of investors by surprise is the rise in U.S. interest rates. Normally when the guns go off, everyone reaches for duration [and] treasuries, . . . bond prices typically go up and yields go down but we’ve had none of that.”
Instead, markets have fast-forwarded to the second phase of an absorbing process from the impact of a new military conflict. He says the inflationary effect of a war was stronger due to the U.S. inflation measures in place before the conflict started.
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“Then you have all of the energy and knock-on effects of those higher prices making the inflation statistics in the U.S. and elsewhere look even worse. Rates rose and that makes sense, but I think it’s also important to remember that wars are stimulative, typically, as well as inflationary.”
Looking ahead, Norelli sees a U.S. market with a Federal Reserve that’s neutral or even restrictive at a time when the economy might not be behaving in a way that warrants it, due to the strong performance from public equities and credit spreads, along with moderately strong gross domestic product growth and upward movement from both the job market and inflation. He’s pricing at least a few hike events from the Fed in the U.S. and other developed markets this year.
“That does not indicate that the policy is currently restricted — that creates an environment where you can see durably higher long-term interest rates.”
If the risk-off or economic weakness comes from an unpredictable big event that pushes central banks to cut rates, bonds will act as a diversifying asset in a public equities portfolio.
“But if the reason for risk caution in the market is rising bond yields — [due to] inflation uncertainty policy, central bank interference, de-dollarization flow — it’s possible in that scenario that bonds and stocks remain positively correlated.”