Corporate bonds mitigate U.S. growth risks

The U.S. is recovering slowly but steadily, which means U.S. corporate bonds are good choices for fixed-income investors.

So says Pablo Martinez, assistant vice president of global fixed income at CIBC Asset Management.

He adds, “The U.S. is working through the issues that led to the 2008 financial crisis, so…economic numbers [reflect] this pattern of sluggish growth.”

However, “we’re [also] seeing positive employment and retail [data], and consumer confidence is [strong]. Even the manufacturing sector is seeing a kind of rebirth in the U.S.”

Read: U.S. unemployment rate edges down

What’s more, the housing and construction sectors aren’t hurting GDP, but aren’t nudging it up as it has in the past.

One important part of the recovery in America is bank lending, points out Martinez. For any kind of revival to be sustainable, this service has to be available. Fortunately, lending activity has been picking up across the country.

But problems persist, he warns. “The reduction of household debt—and also of the debt levels of businesses—is…coming at the expense of government debt. The government has to reduce its involvement in economic activity.”

Its heavy participation is having two negative effects on the county’s recovery prospects, Martinez adds.

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First, “[As] the government reduces its deficit, it will do so by either cutting its expenses or reducing program spending, and that of course will [bring down] GDP.”

Second, he finds political dysfunction in Washington is creating market uncertainty. “We see [this] in the stock and bond markets, and in [consumer] confidence numbers.”

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Martinez adds, “These numbers are high, but every time we see [the words] “fiscal cliff” in the newspaper, [there’s an impact] on the end-consumer’s confidence in the economy and on business investment plans.”

So, investors should expect the U.S. recovery to maintain its sluggish pace for a while. He also predicts low inflation and relatively stable interest rates.

In the fixed-income sector, Martinez proposes investors overweight corporate bonds.

“It will allow them to increase [the] current running yield of [their] portfolios,” he adds.

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Additionally, he says “you look at provincial and federal government yields in Canada, and [then] compare them to corporate bonds. Well, you will gain a significant yield advantage owning corporate bonds.”

This approach lets “investors…diversify their risk by selecting bonds in various sectors. It also allows [them] to overexpose their risk in attractive sectors.”

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If the Canadian and U.S. economies start to perform better than market or analysts expect, we should see yields moving up and bond prices moving down. “In this kind of situation, corporate bonds normally perform better than provincial or federal bonds,” explains Martinez.

“So, in an environment where yields move up, [clients should] have some kind of protection from rising yields” by holding corporate bonds.

Read:

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Why Canada will underperform in 2013, for more from Martinez