Opportunities in High Yield, Emerging-Markets Bonds

This article is part of our coverage of the 2019 Morningstar Investment Conference.

Slowing global growth, trade tensions, and geopolitical risks have fueled market fears of an impending recession and pushed major central banks toward a more cautious stance. Against this backdrop, bond markets are diverging from fundamentals, offering investors some good opportunities, said Sonal Desai, chief investment officer of the Franklin Templeton fixed-income group.

Despite the fact that we are inundated with messages of a global economic crisis, there just isn't cause for massive concern, Desai said in her keynote speech at the Morningstar Investment Conference Wednesday evening. (Desai is the former comanager of Templeton Global Bond TPINX, which has a Morningstar Analyst Rating of Gold, and currently manages a number of other fixed-income strategies for the firm.)

By any measure, the U.S. economy is in good health, she said: Employment is good, wages are rising, and consumer spending is healthy. Productivity growth has led to corporate profits.

Yet fears of recession persist. One reason might be that markets have been drip-fed easy monetary policy for years, and people fear the impact of tightening. The fourth-quarter sell-off in the equity markets reignited these fears and also spooked the dovish Fed into becoming even more dovish, Desai said.

Desai also examined some historical triggers of recession and noted that she doesn't currently see any too much evidence of risk there. For one, the potential for energy prices to create the next recession is low, as the United States has become more self-sufficient in terms of energy production and other countries have become more energy efficient.

Corporate financials are healthy, and though investment in capital expenditures has risen, it hasn't been a massive pickup and there is still room to run, she said.

In terms of the global economy, Desai said that "what we're seeing is moderate, unexciting, GDP growth." She explained that fears of a slowdown in Europe are overblown, and even so, Europe is unlikely to drag the global economy down anyway, as it's an exports-driven region.

She points out that trade wars don't concern her either, as trade patterns have changed. There is less causality between trade and GDP growth than people assumed, she said.

Risks do exist in Desai's outlook, however. For one, households have deleveraged while corporations have become more leveraged.

Another risk is populism: What starts out as social policy often ends up as fiscal policy that needs to be financed, which is a risk to her outlook, she explains.

Against this backdrop, Desai thinks there are opportunities in high yield, particularly on the short end of the curve. Spreads are tight, but default rates are near record lows, so Desai isn't anticipating a spread compression.

"If you're going into spread sectors, it's a time to make selections carefully and actively and pay attention to risk of defaults," she said.

She also thinks emerging-markets bonds continue to offer potential for return, but as with high yield, she prefers lower-duration securities.