In January, many markets moved in completely the opposite direction from the one in which they moved in December. December was a negative month for the riskier asset classes, while January was a good month for them. Equity prices around the globe rose by 5%-10%. Credit spreads on corporate bonds tightened; by 10 basis points (bps) for investment grade and 60bps for high yield bonds. Commodity prices climbed, led by an increase in oil prices of about 15%. OPEC’s planned production cuts of 1.2 million barrels a day may have played a role here. However, government bond markets did not undergo a reversal, with the most remarkable decrease occurring in US bond yields. In a month in which US inflation forecasts were increased by 10-15bps, 5 and 10-year government bond yields declined by about 6bps. This means a drop in real yields of about 20bps.

In the Eurozone, 10-year government bond yields fell by about 15 bps. The spread on the iBoxx Euro Corporate Index tightened by 12 basis points to 160 basis points above the government bond curve. The index earned an absolute return of +1.10%. In January, the spread on the high yield BB index tightened by 42 basis points to 259 basis points above the swap curve. In January, the index earned an absolute return of +2.06%, its best month in nearly three years. Subordinated bonds issued by insurers and non-financial companies performed better than average in January. At sector level, real estate and industrial goods were the star performers.

One major reason for the lower bond yields and higher equity prices was the more cautious tone being adopted by central banks. Equity markets viewed this as support, as the impression had previously been that the Fed, the US system of central banks, would continue to raise interest rates for too long. In October, the market was still pricing in three interest rate hikes by the Fed in 2019. In January, however, prices even briefly priced in a cut to interest rates. This was understandable. In December, Fed chairman Jay Powell continued to claim that the reduction in the Fed’s balance sheet would happen on automatic pilot and that further step-by-step increments in interest rates were likely. Powell adopted a more nuanced tone in January though. The Fed now intends to be patient on further interest rate hikes and the reduction of the balance sheet will now depend on how economic data evolve. ECB President Draghi was also being cautious at the end of January and pointing to the downward risks in the Eurozone economy. There is very little chance of Draghi raising interest rates again before he relinquishes the post of ECB president later this year.

The economic data reinforced the picture of a weakening economy. There are increasing signs that global economic growth is weakening, particularly in Europe and in China. Examples include the economic recession in Italy, the falling IFO business climate index in Germany and Chinese car sales that in December were down 16% on a year earlier. Indicators that measure the extent to which economic data match the forecasts plunged deep into the red in most regions. Several factors seem to be behind the weakening growth, including a slowdown in growth in China, the uncertainty surrounding the Brexit, the difficult trade relations between the US and China and the impact of monetary tightening.

The Kempen Income Fund noted a positive performance in December (+0.43%). The tighter credit spreads on corporate bonds was one important reason behind the positive return. High yield performed even better than investment grade credits. Several positions in supranational institutions experienced difficulty in mimicking Germany’s even lower yields and therefore lagged behind slightly. Several peripheral EU countries, such as Spain, Portugal, Ireland and Belgium, saw the difference in yield with Germany shrink. The slight overweight in these countries made a positive contribution to the return. The underweight in French government bonds did not help, however, as these bonds also performed relatively well. It is noticeable that the differences in long-term yields for countries such as Italy and France versus Germany barely tightened and in fact were more likely to widen slightly, in contrast to the shorter durations. The market is cautious. We reduced the fund’s position in a few non-core EU countries towards the end of the month.

At individual company level, there were positive contributions from the overweights in EDF, General Electric, OMV, Telefonica, CaixaBank, Nokia, Solvay, Adler and Motherson, as well as from the underweights in Rabobank, Ceconomy, Jaguar LandRover, Wind and Gestamp. In contrast, the overweights in Deutsche Bahn, Volkswagen, Becton Dickinson Schaeffler, FCA Capital, thyssenkrupp, as well as the underweights in Generali, Contourglobal and Spie, made a negative contribution.

The portfolio continues to be positioned for higher bond yields and smaller differences in yield versus Germany. There is a great deal of uncertainty surrounding the outlook for growth, but we believe that a reasonably weak economic scenario has already been priced in to bond yields and that economic growth will ultimately continue. The opportunities for an economic upturn in the Eurozone are being underestimated. The central banks are providing a boost to higher bond yields by reducing their quantitative easing.

The material tightening of spreads since the start of this year has led to a decrease in the number of interesting investment opportunities. Combined with the multiple signs of a slowdown in global economic growth and our forecast that the supply of new bonds will increase significantly in the next few months, we remain cautious about the amount of credit risk to which the portfolio is exposed.