Global income:

Tread carefully across asset classes

Income investors looking across asset classes must remain careful. Rising U.S. 10-year Treasury yields created an opportunity in early 2018 to buy interest-rate sensitive equities (in defensive sectors such as REITs and utilities) that had sold off in response to the rise in rates. However, recent market volatility has led 10-year yields to pull back from their highs and lifted valuations for defensive equities. As a result, these traditional income investments are once again more vulnerable to rate increases and offer lower returns.

We continue to believe the traditional income sources of longer-duration fixed income and defensive, income-generative equities should be balanced with some more cyclical equity exposure, as well as allocations to credit investments, where one can earn attractive income without being as exposed to the risk of increases in long-term interest rates.

Fixed income:

Favoring U.S. high yield debt

Within fixed income, we continue to favor U.S. high yield. Without additional stimulus, U.S. GDP growth is expected to dip from a recent average of 3.9% to around 2% in 2019 (source: JP Morgan). U.S. growth also faces a lot less political and geopolitical uncertainty relative to Europe and emerging markets. That said, continued rhetoric around trade, tariffs, Fed rate hikes and broader global central bank policy, combined with relatively tight levels of spreads, is likely to dampen sentiment in the fixed income markets.

Our expectation is that 2019 will see modest spread widening both in investment grade and high yield, making spread duration a critical element of returns. As such, modest GDP growth in the U.S. can support low single-digit returns in the U.S. high yield market and offset the negative impact from higher rates and spreads, while longer duration fixed income asset classes, including investment grade, may deliver another year of negative returns.