What the Divergence Between the Economy and Market Means for Bond Investors

Written by: Tim Benzel, CFA

If one only looked at asset class returns for the second quarter of 2020, it would be reasonable to opine that the world is in a pretty good spot. Stocks enjoyed their best quarter since the 1980s, and, as highlighted in the table below, credit sensitive sectors of the investment grade bond market also posted nice results. However, as we are all too aware, we are in the midst of a global pandemic, and the current economic downturn is as severe as we’ve seen since the great depression.

Why the divergence? We point to the extraordinary actions taken by policymakers to support the economy and financial markets.

The initial stage of the crisis in March was characterized by extreme downside volatility, as investors quickly priced in a deep recession, asset flows turned sharply negative and liquidity dried up. We then had a significant monetary and fiscal response, which improved market functioning tremendously, pushing most asset prices higher. That was Q2.

*Source: ICE/BofA Indices as of 6/30/20. An investment cannot be made into an index. Past performance does not guarantee future results.

Entering the third quarter, we believe the market environment will continue to be shaped by the evolution of the virus, determining which sectors, industries, companies and municipalities will be winners and losers going forward. And while we will likely continue to see pockets of short-term volatility, the support from the Federal Reserve cannot be ignored, which makes a retracement to March levels unlikely.

For bond investors specifically, riskier sectors of the market will likely be supported by the yield hunt from domestic and foreign investors, as sovereign bond yields trade at historically low levels. This makes strong credit research imperative. In our view, value can be added by finding bonds that are trading at reasonable valuations, that have the potential to benefit from the global search for yield, and are backed by credits that have the fundamental strength to survive this downturn.

Eventually, we will move into the last stage off the crisis: recovery. But until we have a better grip on the medical side of the equation, we will struggle to get there. Most importantly, we wish all the best for you, your family and friends, and that you stay safe and remain in good health during this time.

Related: The Dire Outlook for Bonds in the Wake of COVID-19