Data is a crucial foundation for our investment decisions, but what happens when the data is mixed and volatile?
We’ve been speaking to a few fund managers recently, mostly around credit and in particular high yield bonds. Even within the high yield space, fund managers have different takes on the data coming out of particularly the US. The US is around 60% of the high yield market so it is important. But we have also been speaking to a few US fund managers, getting different views on inflation, Purchasing Managers’ Index (PMI), and corporate earnings data.
Let’s start with the PMI data. The July numbers came out higher than expected, 49.8 rather than 49.5. But this still remains the lowest since December. A number below 50 shows goods production is contracting. US import prices have increased 0.4% in July, and export prices by 0.1%. This isn’t surprising given tariffs, though exactly who bears the cost of tariffs remains to be seen. CEO confidence is also down and unless you are in AI or tech, capex is uncertain.
Interest rates in the US remain higher than the UK and Europe, again tariffs are inflationary, so they are a roadblock for the Fed to lower rates. The next meeting is in September and Trump is keen for rates to come down despite the economic data not being totally supportive. Inflation is 2.7% in the US. Employment: payroll numbers have changed little since April, job openings and hire rates are pretty stagnant, so unemployment has remained around the 4-4.2% range since May 2024.
Whether the Fed reduces rates or not is a guessing game. What we as investors are interested in is what is priced into the share price and bonds? If it’s baked in, then great, but our fund managers would say elements are not being priced in. The US equity fund manager we spoke to runs a small and mid cap portfolio and despite strong earnings the companies are not being rewarded by the market, again unless you are AI or tech. The US equity fund manager argues the market underestimates the US consumer.
The bond fund managers are also seeing that some data is not being priced in. High yield managers are seeing a benign outlook, which some think is fine, but others argue there are risks which are not priced in. The managers are moving away from consumer discretionary names in the US and think data is not supportive for the US consumer. Housing data in particular. Most consumers’ largest and sometimes only asset is their house. With high rates over the past few years people were unable to sell and so one of our managers argues that this has led to an over-supply in the market. The funds are finding opportunities elsewhere, in sectors which were beaten up by tariffs earlier this year. Like energy and healthcare.
We’ve all read about historically tight credit spreads – the amount you pay over government bonds. This is true. Spreads haven’t been this tight since 2007. There was a period of tight spreads in 2021 but there was dispersion within the market so managers could find pockets of value, particularly in Europe. European spreads are also very tight at the moment, so where are the managers going? In the high yield space, some reach for yield and go into lower rated bonds, some are willing to pay the spread to remain close to the benchmark.
The high yield market is healthier than previously; it has a lower default rate of around 2% vs its history at 3%. Companies which our funds are investing in have lower leverage and have proven they can pay that leverage down. New issuance is strong, particularly in the US currently. And the quality of the high yield market has gone up. The high yield market rating split was about 40% BB, 40% B and 20% CCC. Now it is 60% BB, 20% B, and 10% CCC. This reflects a significant increase in underlying quality.
There is a diversity of sectors coming into the market, a short-dated bond we saw has been buying Covid (blast from the past) bonds issued by cinemas, cruises and holiday resorts etc. These are all quality high yielding bonds, which will likely be refinanced into lower coupons soon. So, managers are taking advantage of this part of the market.
All the data can be true at once, but with mixed data comes a wide dispersion of opinion. I think it comes down to your risk appetite and where you want to take risk in your portfolio. August data will be interesting as we start to see more of the real impacts tariffs are having on global markets.
Emily Cave – Research Analyst
FPC25491
All charts and data sourced from FactSet
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