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Urgency for positive returns as Japanisation grips
Where could investors find positive real returns1 in today’s markets as Japanisation sets in? We assess how negative rates are spreading across the fixed income investment landscape, and consider the possibilities for investors.
Japanisation2 is usually understood to be a prolonged period of very low growth and low inflation alongside low nominal rates as experienced by the Japanese economy as far back as the late-1980s.
We believe the Eurozone is beginning to show conditions attributed to Japanisation, even if there are also important differences. Key drivers of Japanisation in the Eurozone economy include the financial crisis of 2008-2009 and the sovereign crisis of 2011-2012, which led to extremely accommodative monetary policy without a consequent rise in inflation. In addition, structural deflationary forces such as ageing populations are also in play.
The US-China trade war has further harmed the cyclical growth picture as heavy debt burdens and changing demographics dampen long-term growth and inflation globally, including in the Eurozone. Although the latest newsflow suggests movement towards a partial deal, we continue to believe that, given the profound disagreement on a number of pertinent issues, uncertainty stemming from the conflict will persist.
As real rates (nominal rates adjusted for inflation) plummet to multi-decade lows in G4 economies, fierce debate has erupted over the effectiveness of such loose monetary policy and led to questions about what ammunition central banks have left. With the limitations of monetary policy laid bare, attention has turned to extreme policy frameworks such as the Modern Monetary Theory as well as the need for fiscal stimulus.
We strongly believe that negative real rates are here to stay, especially in the Eurozone, as fiscal policy is unlikely to be used outside of a deep recession. This more permanent reality of negative nominal (in the Eurozone, Switzerland and Japan) and real rates (which includes the US as well) is untenable for investors seeking positive real returns and hoping to benefit from the diversification benefits associated with holding government bonds.
Publicly-traded solutions
How could investors navigate this environment? Various publicly-traded assets could fit the bill, in our view, as they help investors achieve a positive real return objective. Deploying a quality-focused implementation is critical however, as investors re-calibrate the risk profile of their investment portfolios to address the effects of Japanisation.
We highlight opportunities in various LOIM strategies including:
- Corporate credit, especially bonds rated BBB to BB
- Convertible bonds for equity upside while keeping a bond protection floor
- Emerging market fixed income, hard currency debt, especially in Asian credit
- A calibrated multi-asset approach focused on liquidity
- Moving down the debt capital structure of quality/high-rated companies
- Dividend yields in developed market equities.
As negative rates become firmly entrenched, such strategies could help investors find positive real returns.
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