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Is There Value in Asia High Yield Bonds at Nearly 13% Yield to Maturity?

JPMorgan published its Guide to the Market series at the start of the quarter. This time we took a look at the Asia version, and there were a few charts that caught my eye.

As interest rates rose, bond yields have been somewhat reset. It does make some bond segments particularly attractive.

So let us run it through.

A profile of the Chinese Yuan Exchange Rate:

The lesson learned is that currency is volatile. We will struggle to predict the price movement over a seven-year time frame. Next time, if a client worries and asks about our opinion about the Yuan or the USD, we also have to ask what is his or her timeframe.

Is he or she investing or speculating?

The chart below shows the equity valuations in terms of flow (price-to-earnings) and balance sheet (price-to-book):

China has an extensive fifteen-year valuation spectrum. Korea is very narrow. The following regions are flirting with historically lower flow or balance sheet valuation:

  1. China (both)
  2. Taiwan (flow)
  3. Asia Pacific ex Japan (balance sheet)
  4. Hong Kong (balance sheet)
  5. Korea (balance sheet)
  6. Emerging market (balance sheet)

The chart below shows the earnings growth in Asia:

Looks like they are positive on a lot of areas in Asia.

The left chart below plots the valuation in terms of price-to-book and the next 12-month’s price return:

I tend to observe that at the extremes, cheap price-to-book lead to greater returns, and expensive price-to-book leads to poor returns. It is mixed in the middle.

Moving to the United States, the chart below shows the change in operating earnings per share growth and what makes up the composition:

Margin is likely to contract, and on average, earnings growth is -25% in recessions. It is s good question if we get to that extent.

The chart below plots the yield to maturity and the duration:

The duration shows the sensitivity to a change in interest rate.

Purely based on yield, Asia’s high yield looked very attractive. I wonder what the historical debt delinquency rate was. The delinquency rate will inform us of the likelihood of defaults during distress times.

The chart below shows us the different interest rate sensitivities:

USD Asia credit, high yield and the floating rate are less sensitive to the interest rate. Whether the interest rate are up or down, it affects them less.

What affects them more may be equity risk.

Essentially, they are closer to equities than they are to bonds.

The chart below will further your education on bonds:

What drives high-yield bonds and emerging market debt is more the income and less the interest rate. What drives developed market sovereigns is mainly price return.

Many bond types are closer to the lower bound of their 10-year yield spread. US high yield, investment grade, emerging market corporates.

The chart below shows the 32-year high-yield bond default rate:

When times are good, default rates are relatively low. But during the recession, the default incidence spiked up. Price falls and the yield spread to worst expands. It remains to be seen when recession comes how well high-yield bonds would do this time.

We have a period where the USD was very strong. Typically, emerging markets tend to suffer because their debt is in USD and a strong USD means they have to repay more.

But it seems this time, a lot of emerging markets are far stronger than last time.

Asia high-yield and emerging market debt (EMD) stood out.

I always see an S&P 500 calendar year versus intra-year decline chart out there, but I seldom see one on Asia Ex-Japan. I appreciate this chart.

Every year, there are some drawdowns.

But my god, the drawdown for Asia ex-Japan is very deep relative to the S&P 500!

On a longer-term time frame (right chart, 5-years), there seem to be a closer relationship between current market valuation and future five-year return. The relationship is closer at both ends.

It is less clear in the middle.

US corporate markets have started to contract.

This is a favourite slide to coach clients:

To recover to Dec 2021 high, you will need to capture a 26.7% gain in one-year.

That looks daunting.

But if you view it from a five-year time horizon, it will take 6.4% a year returns for five years to make back. You can identify better with 6.4% if you compare it against the average expected returns of equities.

There seems to be a close relationship between unemployment and market bottoms. As unemployment spikes up and runs its course, market tend to find the bottom.

Right now, we have not seen any unemployment spikes.

The only period where this does not work was in March 2001 to November 2001.

The 60/40 portfolio is far from dead.

This chart shows us the portfolio return from 1950 to today, which is 72 years.

During this period, we endure much.

Yet we find it uncommon that the 60/40 portfolio will have back-to-back down years.

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