Bear Market Buy Opportunities: JPMorgan

A common misconception about bond portfolio managers is that they are just looking for yield.

But for strategists like Oksana Aronov, who leads market strategy for alternative fixed income at JPMorgan Asset Management’s $759 billion fixed income division, it involves much more than that.

Speaking on Bloomberg’s What Goes Up podcast on June 30, Aronov explained how she’s able to use a variety of different strategies to take advantage of bonds that offer absolute returns and why that’s vital in today’s environment. .


bear market

environment.

“Over the past 10 years, fixed income has become a wealthy asset class,” Aronov said on the podcast. “We really tried to preserve this focus on preserving capital first and then with that, ‘What’s the best return I can offer?'”

Fixed income securities are a class of assets that make fixed payments on a fixed schedule, such as government treasury bills and corporate bonds.

Taking an alternative approach to fixed income means Aronov can go long or short on bonds. This flexibility has been extremely important in recent years, as bond prices have reached record highs while interest rates have been near zero.

Bond prices move inversely to interest rates.

During this period, many bond investors moved lower on the risk curve to find more rewarding returns driving up the price of junk bonds, which is one of the riskiest areas of the market.

A new diet

It’s a move that could weigh on some investors as the economy enters a new regime of rising interest rates, soaring inflation and slowing growth.

“I think in fixed income it must also be a question of price,” Aronov said. “I think it’s because we’ve forgotten that price matters that investors were buying high yield bonds at $107 or even higher, or several dollars above par, that they’re sitting on the losses on which they are sitting at the moment.”

With interest rates rising, the era of accommodative monetary policy and ultra-low default rates is coming to an end. So it’s a question of the cost of capital and its impact on profits even for the best capitalized companies.

“In an environment where we are at such minimal levels of default that they have almost nowhere to go, which means that again paper losses have the ability to become real real losses,” said Aronov.

The driving force behind this change is the


Federal Reserve

which raised interest rates to curb spiraling inflation.

“I think (Jerome) Powell made it very clear that it’s important for him to go down in history as someone who contained inflation,” Aronov said on the podcast. “So they will continue to choose inflation over growth as long as inflation remains a high issue.”

Rising interest rates mean tighter financial terms and less capital, which will accelerate the default rate, Aronov said. The Fed is unlikely to pivot because its only desire is to rein in inflation, not prop up zombie companies and the junk bond universe, she added.

Only if investment quality spreads start to push 300 basis points will investors start to see support from the Federal Reserve, she said.

Right now the spreads are around 150 basis points. They’re just crossing the threshold of the “benign” 2018 hiking cycle, Aronov said. This suggests there is still more room for maneuver given that inflation is now at its highest level in four decades compared to inflation above 2% in 2018.

“To call it a good deal from a spread perspective, I think we’re a long way from that,” Aronov said.

“All the carnage we’ve seen in the bond markets…it’s all been driven by interest rates,” Aronov said. “Very, very few of them have actually been focused on spread or credit risk and we need to see that punch to start talking about opportunities.”

The current playbook

With this pessimism, Aronov is cautious because she believes that if the expectations around a


recession

and a slowdown in construction, then spreads will continue to widen.

“Remember that you don’t have the same


liquidity

the fundamentals of this market that you were used to,” Aronov said. “The sell side is not there to take those obligations away from you. Price discovery therefore becomes very, very violent. We’ve seen it all before and it’s going to happen again.”

To maintain capital preservation for now, Aronov remains in cash and highly liquid assets, such as high-quality floating rate bonds.

“The reality is that if you’ve been in cash, over the last five years you’ve basically outperformed the overall Barclays index, year to date, one year, three years and depending on the day, yes, even five years.”

However, Aronov could soon use this liquidity to seize opportunities.

“Probably in the next few months or two months we’re going to start transitioning, start getting aggressive, start chasing those returns as part of the cycle, as we see the spreads widening and some of those more bearish expectations are reflected in the price,” Aronov said.

It’s time to get aggressive

A sign of when to turn aggressive is to find a tipping point toward capitulation, Aronov said. Right now there are the ingredients for surrender, but that just isn’t reflected in the price yet, she added.

This is important because she notes that the only historical parallel to this current environment is the late 1970s to early 1980s, when inflation was rising and most assets were struggling on a real return basis.

According to Aronov, the market sectors that are beginning to look “ripe” for investment are fixed income assets with a correlation to equities such as convertibles and closed-end funds, which are already at a significant discount.

“I think it might be at the top of our shopping list for the foreseeable future,” Aronov said. “But we’ll see how the rest of this market plays out.”

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