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Vanguard sees 2020 slump in credit returns as US growth sputters
AFTER a banner 2019, returns from US credit will slump next year as economic growth falters, according to Vanguard Group Inc.
The US$5.9 trillion asset manager expects investment-grade bonds to gain 2.5 per cent to 3 per cent, down from 14.6 per cent so far this year as at Dec 13.
"Most of the juice of credit has been squeezed from the orange," said Joe Davis, Vanguard's global chief economist and head of the investment strategy group. "It's more carry-like returns for most parts of the market."
Vanguard's outlook hinges on its forecast for just one per cent US economic growth, less than the 1.8 per cent consensus for 2020. Uncertainty about trade and other geopolitical events has hurt investment and the slowdown will be most pronounced in the second half of next year, said Mr Davis in a Dec 12 telephone interview.
"The riskier parts of the capital markets are assuming a lot of things go right in 2020. Our caution to investors is that it's not clear everything will," said Mr Davis.
On the flip side, Vanguard sees just 25 per cent odds of a recession in 2020 because of the strength of consumers. "To be bearish on the credit markets, one has to think there are significant odds of recession coming," he added.
And Vanguard isn't fazed by the fact that this credit cycle has lasted more than 10 years. According to Mr Davis, the longest expansion in US history is 17 years, so the latest run could persist. "The more frustratingly low economic growth is during the expansion, the longer it is," said Mr Davis.
Over the next two years, Vanguard doesn't expect a material rise in interest rates. Yield curves across the world will "steepen modestly" as markets price in reflation, said Mr Davis, who also expects this influence to fade.
In high yield, which has returned more than 13 per cent this year, Davis says investors "should be very happy" with a 4.5 per cent to 5 per cent gain in 2020.
Downside risk has increased because of the strong recent performance, but Mr Davis said that a lack of "highly speculative activity by investors" is reason to not be too bearish.
"For savvy investors, the tighter credit spreads become, the more guarded they have to be in their strategy," said Mr Davis. "When the next recession hits, the downturn in the financial markets could be worse than the economic effects."
For those seeking more risk, particularly in junk bonds, Vanguard recommends a long-duration bias. Mr Davis also suggests diversifying into emerging market debt to get extra yield.
Vanguard forecasts US equity returns in a 3.5 per cent to -5.5 per cent range. This is "largely because of the valuations, less so because of the fundamentals", said Mr Davis. BLOOMBERG