Despite volatility, which will likely continue, we have a favorable view of high yield bonds given their intact fundamentals and relatively steady default rates. We also adjusted our view on global fixed income upward to a slight underweight.
Global Fixed Income
Treasuries: Committee members held steady at an underweight stance for U.S. Treasuries, believing that they remain overvalued based on our outlook for marginally higher interest rates over the next 12 months. With the Fed's first rate hike behind us, investor focus will likely shift to the pace of tightening over the next year and beyond. We believe that the path to rate normalization will be slow and steady, but prefer exposure outside of U.S. Treasuries within investment grade fixed income.
Global Fixed Income: Ongoing ECB Stimulus Could Support Yields
Source: Factset. Data as of December 10, 2015. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
Developed Market Non-U.S. Debt: Government bond markets currently offer a mixed bag, with yields that remain low for most countries. Additional stimulus by the ECB, and potentially more from the Bank of Japan (BOJ), is likely to provide an ongoing source of demand for developed market non-U.S. government bonds for an extended period of time. Within Europe and Japan, we believe that opportunities for tactical long positions should present themselves as markets remain choppy and sensitive to global inflation, growth and central bank expectations. Currency movements will likely remain a swing factor - although we do not anticipate a weaker dollar, the prospect of Fed tightening compared with the easing we are seeing elsewhere in the world is likely reflected in currency prices.
High Yield Fixed Income
We are maintaining a slightly overweight view of high yield fixed income. While we anticipate volatility in the near term, the recent selloff and spread widening has resulted in elevated yields and opportunities in the non-investment grade fixed income market. We believe selectivity will remain paramount, but high yield fundamentals remain intact, including default rates that have stayed relatively steady. High yield spreads likely troughed approximately a year-and-a-half ago, but we believe that the credit cycle has a few years left before conditions become more challenging.
High Yield Fixed Income: Spreads Are Exaggerating Default Risk
Source: JP Morgan, S&P/LSTA, data as of November 30, 2015. Defaults based on par amounts. High yield spread to worst is represented by the JP Morgan Global High Yield Index. It is an estimate of the difference between the worst performing security and the best. Leveraged loans spread is represented by the discount margin (three-year life) of the S&P/LSTA Leveraged Loan Index.
Emerging Markets Debt
Our neutral view for emerging markets debt, as well as our preference for hard currency sovereign debt over local currency and corporate debt, remains intact despite a cautious near-term outlook for emerging markets. Fundamentals are stressed due to weak economic growth and the challenging commodity cycle, but we feel that continued support offered by the low-yield environment, limited supply and already light investor positioning can help mitigate risk. The recent selloff has sent spreads and FX to levels last seen at the peak of the global financial crisis, suggesting that much of the deterioration may already be priced in.
U.S. dollar strength and negative country-specific idiosyncratic developments are also weighing on fundamentals. Domestic demand is declining as countries face deleveraging challenges following years of strong credit growth. Still, we remain comfortable with underlying sovereign credit quality, supported by strong public-sector balance sheets, low external debt ratios and flexible exchange rate regimes. The benign inflation environment should allow central banks to maintain an accommodative monetary policy stance.
About the Asset Allocation Committee
Neuberger Berman's Asset Allocation Committee meets every quarter to poll its members on their outlook for the next 12 months on each of the asset classes noted. The panel covers the gamut of investments and markets, bringing together diverse industry knowledge, with an average of 24 years of experience.
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The views expressed herein are generally those of Neuberger Berman's Asset Allocation Committee which comprises professionals across multiple disciplines, including equity and fixed income strategists and portfolio managers. The Asset Allocation Committee reviews and sets long-term asset allocation models, establishes preferred near-term tactical asset class allocations and, upon request, reviews asset allocations for large diversified mandates and makes client-specific asset allocation recommendations. The views and recommendations of the Asset Allocation Committee may not reflect the views of the firm as a whole and Neuberger Berman advisors and portfolio managers may recommend or take contrary positions to the views and recommendation of the Asset Allocation Committee. The Asset Allocation Committee views do not constitute a prediction or projection of future events or future market behavior. This material may include estimates, outlooks, projections and other "forward-looking statements." Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
A bond's value may fluctuate based on interest rates, market conditions, credit quality and other factors. You may have a gain or a loss if you sell your bonds prior to maturity. Of course, bonds are subject to the credit risk of the issuer. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the investor's state of residence. High-yield bonds, also known as "junk bonds," are considered speculative and carry a greater risk of default than investment-grade bonds. Their market value tends to be more volatile than investment-grade bonds and may fluctuate based on interest rates, market conditions, credit quality, political events, currency devaluation and other factors. High Yield Bonds are not suitable for all investors and the risks of these bonds should be weighed against the potential rewards. Neither Neuberger Berman nor its employees provide tax or legal advice. You should contact a tax advisor regarding the suitability of tax-exempt investments in your portfolio. Government Bonds and Treasury Bills are backed by the full faith and credit of the United States Government as to the timely payment of principal and interest. Investing in the stocks of even the largest companies involves all the risks of stock market investing, including the risk that they may lose value due to overall market or economic conditions. Small- and mid-capitalization stocks are more vulnerable to financial risks and other risks than stocks of larger companies. They also trade less frequently and in lower volume than larger company stocks, so their market prices tend to be more volatile. Investing in foreign securities involves greater risks than investing in securities of U.S. issuers, including currency fluctuations, interest rates, potential political instability, restrictions on foreign investors, less regulation and less market liquidity. The sale or purchase of commodities is usually carried out through futures contracts or options on futures, which involve significant risks, such as volatility in price, high leverage and illiquidity.
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