The path forward for bonds in Q4

New opportunities in three emerging themes

An investment strategy has a limited shelf life. Sectors and companies that are unfairly out-of-favour are found and rehabilitated. Trends play out. And the tectonic forces that move markets over longer cycles gradually re-tilt the playing field in favour of different and new opportunities.

Consequently, as investors, we need to readjust frequently. Over the last couple of years, we have made hay in some industrial groups that were victims of the post-Covid momentum bust, a trade we liked to call “Cathie Wood T+2.” We also clipped some serious coupon from the surviving companies of the 2020 negative price episode in the oilpatch. And we rode the rebound in rate-reset preferred shares from their ridiculous lows. But, as they say, that was then. And this is now.

Looking into the market during these fading days of the summer of 2024, we see some new themes emerging. One important driver appears to be the degree to which companies are finding profits harder to generate. Whether it is the lagging effect of higher interest rates or the fading of pandemic era stimulus funding, we observe portfolio companies dealing with fewer customers for their wares and lower prices being paid by the customers they still retain.

Another theme is the trend towards lower policy rates from central banks. So far, the U.S. Federal Reserve had held out from the rate cutting crowd, but after Fed Chairman Powell’s capitulation at the annual Jackson Hole, Wyoming economic symposium, the die appears cast for the American central bank to follow the scores of others in walking back, at least to a degree, the unprecedently sharp hiking cycle of the past two years.

Three emerging themes

And a final theme that seems worth noting is flagging momentum in some of the more successful trades of the past decade. Investors who favoured American stocks and bonds, whose passive strategies led them into large companies versus small, and who favoured growth versus value, have done disproportionately well. Perhaps too well. And so, we are busy looking at credit exposure in smaller, ex-U.S. value-type companies.

We will have more to say on these themes in future commentaries, but for now, we find ourselves chipping away at positions within a new opportunity set:

Utilities: With a market that has been so focused upon growth, a sort of shadow effect was that stability of earnings may have been an underappreciated factor. And so, from this area having been almost a non-category for us a couple of years ago, we now own approximately $90 million of securities of utility companies. And, in utility positions, our emphasis has been on widespread or equity-sensitive lines that stand to gain, in our view, the most revaluation from renewed investor attention to the sector.
U.S. dollar fade trades: Another characteristic of the recent cycle was a very strong U.S. dollar. Although purchasing power measures and balance of payments were against the greenback, the Fed’s relatively aggressive funding rate stance may have propped up the U.S. dollar. With this trend poised to reverse, the runway looks good for some non-U.S.-domiciled credits like Petróloeos Mexicanos (Pemex), or precious-metals sensitive holding like Equinox Gold Corp converts.
Real estate: Truthfully, it has been hard to find commercial real estate securities in the last year or so where we can build enough conviction to pull the trigger. But lately, the few names where we have exposure to real estate valuations have started to work. And so, we continue to look, in this area, to expand from a small base.

Now, regular readers of our commentaries will understand that we often make money despite our strategy as opposed to because of it. And we will never let our big picture view prevent us from bending down to pick up a twenty-dollar bill we see lying on the sidewalk. But, on the margin, we do see a new kind of opportunity in the fall of 2024 aligned with these emerging themes.

Geoff Castle is Lead Portfolio Manager of PenderFund Capital Management’s Fixed Income Portfolios, including the Pender Corporate Bond Fund. Excerpted from the Pender Fixed Income Manager’s Commentary, August 2024. Used with permission.

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