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How Asia's Fixed Income Market Brings Back Memories of 1994 and 2013

The story sounds a bit too familiar

If past is any sort of prologue, don't be a bear on risk assets and do be a bull on Asian high yield bonds — that's the call from Lombard Odier Investment Managers.

They argue that following the crowd isn't the right move, even after the brutal couple of months for bond markets following Donald Trump's surprise election win.

Global bonds lost more than $2.8 trillion since the vote on expectations the president-elect's efforts to increase government expenditure will spur economic growth and stoke inflation. That sent a gauge of Treasuries volatility surging to the highest since February.

The benchmark 10-year U.S. Treasury yield soared to 2.55 percent on Thursday, up more than 80 basis points in just two months. That's such a quick reversal from the record-low 1.318 percent reached in July.

"To be honest, the drawdown in the bond market during November was unnerving, both to investors and fund managers," Lombard Odier's Asia fixed income investment team says in its 2017 outlook report. "Almost every 2017 outlook issued by banks which we have read so far, is bearish on bonds. And more so towards EM and Asian bonds."

The company's high yield-focused strategy is being reflected in its portfolio, with 37 percent of its Asia Value Bond Fund being dedicated to the asset class. The average duration is four years and a weighted average credit rating is BBB-.

The Geneva-based asset manager wants to "question the current wisdom of the crowd" and get exposure to riskier debt in the region "as much as possible."

Its confidence comes from lessons learned in 1994 and 2013, with markets now bearing a striking resemblance to those years.

In his first term, then-President Bill Clinton rolled out plans for massive fiscal expansion, prompting the Federal Reserve to "suddenly" raise the interest rate. About two decades later, then-Fed Chairman Ben S. Bernanke "unexpectedly" signaled the end of the bond-buying program, which ended up adding $3.5 trillion to the central bank's balance sheet.

Fast-forward to December 2016, and the market is in a similar place, given Trump's reflationary rhetoric and a Fed that's already tightening policy.

"In both instances [of 1994 and 2013], the markets reacted over the next few months with higher equity prices followed by stronger [high yield] markets," Lombard Odier's analysts wrote in the report. "We think this time will not be much different."

The sharp surge in Treasury yields is actually "a boon" for those seeking long-term investment opportunities, rather than something to fret about as some fund managers are doing, Lombard Odier argues.

"We will now be able to reinvest coupon and compound at much higher yields, in an environment where credit risk is supposedly lower," it wrote in the report. "In fact, the worst thing that could happen now is for Treasury yields to go back down to the all-time-lows reached post-Brexit."

Lombard Odier's other trading recommendations:

  • The "strong parallels" to 1994 and 2013 indicate bond buyers may "crowd into" short and mid-term maturities in the coming year, steepening the yield curve and making the long-end "unloved and eventually cheap."
  • Mid-dated Asia and emerging market high-yield bonds at 5 to 7 percent is particularly cheap, and the firm has positioned the fund into this area as much as possible.
  • The firm's top picks include India's commodity sector as well as property developers in Indonesia. Utility sectors in both countries as well as Sri Lanka's front-end sovereign bonds are also on their watchlist.
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