The second phase, “embrace duration,” revolved around the expectation that central banks would soon cut interest rates, an action that would lower the entire yield curve. The mathematics of duration, which benefits investors when yields decrease, prompted the strategy, Headland explains, to extend duration in the portfolio during a weakening economic cycle, thus maximizing returns while adding safety.
The third phase involves capitalizing on economic downturns – taking on risk. As the economy approaches the bottom of the cycle, high yield spreads widen, reflecting the market’s increasing concern over default risks. This dislocation presents an opportunity for investors to assume greater risk at attractive prices. As the market recovers and spreads begin to narrow, significant returns can be generated, particularly in riskier asset classes. At this stage, the strategy shifts focus from safer, longer-duration bonds to shorter-duration and lower-quality corporate credits, adjusting the portfolio to capture potential upsides as conditions improve.
Finding our place
Nia emphasizes the importance of adopting a regional perspective rather than viewing the global economy as a uniform entity. Currently, there’s a phenomenon of either synchronization or desynchronization in economic growth patterns across different areas.
“For instance, in the United States, we find ourselves navigating between what might be considered phase one and phase two of economic recovery,” Nia points out, “However, it remains uncertain how swiftly we can transition from phase two to phase three. The U.S. economic data presents a mixed picture: for every three bullish arguments, there are also three bearish counterarguments, indicating a balanced yet uncertain outlook. We generally perceive the U.S. as entering phase two.
“In contrast, regions like Canada and Europe appear to be more firmly entrenched in phase two. This difference is also reflected in central bank policies. Canadian and European central banks are likely more inclined to begin reducing interest rates sooner than the U.S., where rate cuts might not be anticipated until the end of the year. This divergence underscores the importance of considering regional economic conditions and central bank strategies when analyzing the global economic scenario.”