It’s that time of year when banks begin issuing some brave outlooks for the year ahead. The latest is from UBS.
Among their key recommendations are corporate bonds (including junk), which they say will draw increased investor appetite in 2009 as financial conditions stabilise. Here’s how their overall asset class weightings are headed for the year:
With corporate bonds, they see attractive risk-adjusted returns in a world of otherwise low nominal returns. Specifically:
We favour investment-grade corporate bonds at present, but look to extend into high yield bonds as the economic and financial environment stabilizes.
Meanwhile, as can be seen above, they’re also recommending a significant move into inflation-linked bonds. This makes a lot of sense. While inflation is highly unlikely to return in 2009, ‘linkers’ are currently discounting too high a probability of sustained deflation they say. And, even in the case of sustained deflation, linkers will still protect as coupons never go negative.
Amongst other themes, the investment bank is predicting a major re-hashing of equity valuations as a ‘tsunami’ of bad earnings reports and downbeat corporate outlooks get under way. Eventually, though, they say the bad news will be discounted, setting the stage for a more durable recovery of risk assets.
The big no-nos they say are inflation-plays:
In 2009 inflation is ‘dead’ given global recession, mounting spare capacity, and weak commodity prices. That is not to say that inflation-linked bonds are a bad investment. They currently discount persistent deflation, which we doubt will occur. They are good value at lower risk.
UBS also warns against betting on any supply-related jump in yields. While governments will be running up massive deficits, they say yields aren’t likely to rise for that reason - at least not yet.
…overall, we believe that when government bond yields eventually begin to rise, it will be because growth expectations have improved and risk premiums have declined, not because investors can’t digest the big supply in the pipeline
As for which indicators will finally signal a market recovery? They say:
* Narrowing inter-bank spreads
* Narrowing corporate bond spreads
* Declining mortgage rates
* Increased issuance of corporate bonds, commercial paper
* Falling volatlity, unwinding of risk-aversion trades.
We will have to check back at the end of 2009 to see how those recommendations fared.
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