No, that’s not what Jerome Powell just told you! JPMorgan’s Bill Eigen warns investors not to go back to fixed income.
Few bond fund managers burst into contagious laughter when discussing the market’s reaction to the latest inflation data released on Thursday. A 0.3% rise in the consumer price index between September and October – two tenths less than economists expected – sparked a huge rally in bonds. The two-year Treasury yield, a barometer of Fed policy, fell to 4.32% from 4.63%. Rate hikes have rattled markets this year, inflicting historic damage on bonds.
Between laughs, Bill Eigen, portfolio manager of the JPMorgan Strategic Income Opportunities Fund, had a lot to say about how investors are misinterpreting inflation data. “That means the Fed is done. It’s finish. They will stop now. That’s what the market values! it exploded.
Eigen is always up for a boisterous conversation about what’s going on behind the curtain in fixed income, especially when he’s doing the opposite of everyone else, which is often – and perhaps all. time. Unlike most traditional bond managers, Eigen has that freedom. Strategic Income Opportunities is a go-anywhere absolute return fund that can go long and short and is not judged on its performance relative to its peers. His thought process is different because the fund’s mandate is to generate positive returns no matter what happens in the fixed income markets.
The signs of trouble are clear, he said, even if no one is paying attention. High yield is trading at 450 basis points against Treasuries, implying that there are virtually no defaults and that the economy is healthy, if not robust. But Eigen isn’t buying it. Despite the recovery, inflation is not coming down significantly anytime soon. At the same time, defaults have started and junk bond issuers are not closing deals.
“People are celebrating an almost 8% CPI print,” he said. “This is the Fed’s fourth pivotal rally this year.”
But then Fed Chairman Jerome Powell comes back even more belligerent because, as Eigen put it, “the Fed’s job isn’t even close to being done” and investors give it back. For years everyone said “don’t fight the Fed”, but now that the Fed is the most aggressive in 40 years, clearly laying out its path, people aren’t listening. “All I do is listen to the Fed, and I believe them.”
Eigen’s thinking, as well as the positioning of the fund, tells a particular story about fixed income markets and how the world got to where it was.
Last year, Eigen watched with suspicion the Fed’s easy money policies combined with government stimulus. “It’s the most defensive positioning I’ve ever had in my entire career.” Eigen, who also heads the absolute returns and opportunistic fixed income team at JP Morgan Asset Management, holds 60-70% of the fund in cash. Last year, he sold all high-yield securities and took short positions in parts of the credit default swap market, including investment grade and high-yield securities.
He became even more defensive in January. Inflation was accelerating, reaching 5 to 6% in February, but the Fed remained immobile. In fact, it was doing quantitative easing until March. “I thought that was the definition of insanity. We are sowing the seeds of something awful here and the Fed is acting like everything is transitory.
Eigen is now patiently waiting to put the money from the fund to work. “I need to see high theft, I need to see signs of real liquidity release. I see it in some segments, like some MBS, CMBS melting completely. You see some stocks going from par at 60, but nobody talks about it. Throughout my career, that’s always how it starts.
He has a habit of running the other way. In 2016, the fund took on high yield at a time when the market hated junk bonds or, as he colorfully put it, “they were in the toilet”. Now there is a chorus of criticism for his cash position. But the fund is down just over 20 basis points, even as most core and core plus bond funds were down nearly 16% through the end of October.
Bond managers must share the blame. Since the 1980s, fixed income securities have been in a bull market, with rates constantly falling. Few people have managed money during a bond bear market. And this time around, with rates close to zero, investors had no income to cushion the declines in value.
Eigen says the double-digit losses investors have suffered highlight other perennial mistakes. With rates so low for so long, investors fell for strategies that promised more returns without more risk. “My military dad always said, ‘At some point, you have to pay the price for the things you’ve done.'”