By Randy Myers
The 2008 housing bust and credit crisis may be fading into the rearview mirror of history, but they are continuing to drive developments in financial markets and much of the global economy. After triggering what has been termed the Great Recession, the financial market crisis has left the developed world contending with what might be called the Great Deleveraging—a monumental process of debt reduction. It is a process, Christine Hurtsellers told participants at the 2011 Stable Value Fall Forum, that is in its early stages.
Hurtsellers is chief investment officer for fixed income and proprietary investments at ING Investment Management, which manages about $163 billion for institutions and individual investors. She said the current deleveraging process will take a long time, in part because it is global in nature and in part because developed-economy governments and the private sector alike piled on such massive amounts of debt and leverage for more than a decade leading up to the financial crisis. Sovereign debt-to-GDP ratios are now at historic highs and expected to rise even further, particularly in the developed economies, as governments continue to borrow to finance crisis-related stimulus programs.
In the midst of such negative news, many investors have sought shelter in the safety of U.S. Treasury bonds, which, at the long end of the yield curve, generated total returns of about 25 percent through the first 11 months of 2011.
That flight to safety was not surprising given past history, Hurtsellers noted. She cited a study by the consulting firm of McKinsey & Co. of 45 previous deleveraging episodes, 32 of which followed a financial crisis. The typical characteristics, she said, included belt-tightening by developed markets for about half a dozen years, accompanied by a recession. Households tended to save more and businesses tended to invest less, slowing economic growth. Governments devalued their currencies in a bid to boost exports.
Despite the obvious hurdles, Hurtsellers told her audience she is bullish on the United States. While its recovery from the financial crisis has been weak relative to previous post-recession recoveries, she said, it is nonetheless on track compared to the earlier post-bust recoveries in countries where, as in this case, housing was at the core of the crisis.
Still, Hurtsellers warned, fixed income investors should be prepared for bond yields to remain low for some time. They also should expect shorter and more volatile business cycles, given that the Federal Reserve has relatively few stimulus tools left at its disposal.
However, she stressed that short-and long-term rates have been explicitly anchored by the Fed, which has eliminated one source of bond market volatility. Over the long run, she said, reduced volatility will be supportive of credit markets and help to contract the yield spread between Treasuries and riskier credit products.
Not everyone shares her optimism, of course. Hurtsellers observed that corporate credit markets are priced for a recession, even though U.S. corporations hold nearly $1.5 trillion in cash on their balance sheets and the collapse of the securitization market has reduced the supply of credit products.
“We have a lot of negative sentiment priced into the market,” Hurtsellers said. “But as an asset manager, I’m trying to forge ahead by buying risk assets; something I started doing in September.”
Hurtsellers advised fixed income managers to “buy what you believe in.” While fundamental research would be important, she stressed that “great business models are out there (in the private sector). You can buy great credits and weather this storm.” She advised buying high-quality spread assets with liquidity to help ride out the market’s inevitable volatility.
Hurtsellers also recommended overweighting emerging-market sovereign debt. She said post-crisis policies in the United States are helping to keep the dollar under downward pressure, particularly against emerging-market currencies. And, she said, emerging-market economies are in some ways more fundamentally sound right now than their developed-market counterparts.