Global bond review


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Global bond review

  1. 1. Global Bond ReviewLate year rally for globalbond markets • Global risk assets enjoyed a positive month Key • Central bank policy remains highly supportive points • Western Asset believes the global economy will expand at a moderate pace in 2013 This material is not for public distribution outside the United States of America. Please refer to the disclosure information on the final page. In the united states — iNVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE1212 Batterymarch I Brandywine Global I ClearBridge Advisors I Esemplia Emerging Markets Global Currents I Legg Mason Capital Management I Legg Mason Global Asset Allocation Permal I Royce & Associates I Western Asset Management
  2. 2. Market review Despite mixed economic releases and the looming threat of the fiscal cliff to the US economy, risk assets globally enjoyed another positive month. The exception was US investment-grade corporates, which digested disappointing US third quarter corporate earnings. Lower credit quality and financial issues, especially in Europe, again led advances with yields on external and local emerging market (EM) sovereigns approaching all-time lows. Peripheral European sovereigns also fared well on growing optimism for more financial aid for Spain and Greece, further lowering systemic risks within the eurozone. Despite no policy moves by any of the major central banks, core government bond yields fell as sluggish growth kept alive prospects for further easing. Economic data globally remained consistent with subpar growth, led by weak government and business investment, although regional differences have started to emerge. In particular, most Asian economies, including China, appeared to be recovering on a revival in technology-led manufacturing. European economies appeared to be stabilizing. In contrast, the outlook for the US economy was clouded by the expected fiscal contraction while Japan’s, India’s and Brazil’s economies remained fragile. In projecting another year of sub-2% growth in 2013, the Organization for Economic Co-operation and Development1 described the global economy as,“…far from being out of the woods.” Discounting Hurricane Sandy’s temporary effects on consumption, the US economy continued to post mixed signals. Growth in the third quarter was revised higher to 2.7%, although this was largely driven by higher inventories. Fourth quarter growth is now expected to be below 2%. The housing recovery remained in place despite a stalling in new-home sales with builder confidence rising to six-year highs. A recovery in core capital goods orders, a firm non-manufacturing ISM2 figure and a gradually recovering labor market were contrasted by weak corporate earnings and a decline in the manufacturing PMI3 to below 50 for the first time in three months. In Europe, market sentiment remained positive as Greece was rewarded for passing additional austerity measures with support from its international creditors to delay its deficit reduction target by two years and receive €34 billion in financial support. Spain also made progress in recapitalizing its banking system by accelerating the consolidation of four nationalized banks and substantially writing down and transferring their real estate assets to the government’s “bad bank”. This earned the approval by the EU of the transfer of €39.5 billion in funding to recapitalize the banks. Spain’s economy remains mired with unemployment rising to a record 4.9 million, helping push up Europe’s unemployment rate to a record 11.7%. While the eurozone economy is expected to remain in recession in the fourth quarter after shrinking 0.1% in the third quarter, business and manufacturing surveys rose in November. The European Central Bank (ECB) remained on hold despite citing risks to the economy outweighing those to inflation. Economic data and business surveys in the UK continued to point to stagnant growth. However, mortgage approvals appeared to be recovering. Public sector borrowing for October, however, was substantially worse at £8.6 billion than in the corresponding month in 2011. The Bank of England remained on hold despite a dovish inflation report and little evidence that the Funding for Lending Scheme4 has stimulated lending to small businesses. China’s economy continued to show signs of recovery, although it was still focused on the investment and export related sectors. Manufacturing PMI remained above 50, led by new orders and exports, which expanded by 11.6% in October and pushed the trade surplus to a four-year high. Fixed-asset investment, industrial production and retail sales were also firmer than expected. The appointment of new leadership announced during the month was not expected to impact the economy, although prospects for further stimulus have declined as the economy has rebounded. 1  The Organisation for Economic Co-operation and Development (OECD) is an international economic organisation of 34 countries, founded in 1961 to stimulate economic progress and world trade. 2  The Institute for Supply Management (ISM) is an association of purchasing and supply management professionals, which conducts regular surveys of its membership to determine industry trends. 3  The Manufacturing Purchasing Managers Index (PMI) measures economic activity in the manufacturing sector, based on survey data collected from manufacturing firms. 4  The Funding for Lending Scheme (FLS) is a UK government initiative designed to encourage bank lending by supplying low cost funding to lenders.2
  3. 3. Despite weak growth continuing in India (exacerbated by a disappointing monsoon season), the rest of the Asian region is recovering. Taiwan and South Korea are benefiting from stronger technology-related spending, while domestic demand is boosting the Philippine, Thai and Singaporean economies. Japan’s economy has slipped back into recession after third quarter growth contracted by 3.5%. Weak exports and capital spending are expected to keep growth negative in the current quarter. [A subsequent change of leadership in December’s elections has raised expectations of significant fiscal and monetary easing to stimulate the economy.] Australia’s Reserve Bank cut rates to a 50-year low of 3%, citing concerns over a peak in mining related spending and unemployment rising to a two-year high. Elsewhere, Brazil’s central bank refrained from cutting rates. The economy’s recent recovery stalled in the third quarter, with growth up only 2.4% on weaker services spending. Figure 1: Government bond yields (%) 10-year UK 10-year US 10-year Germany 4.5 4.0 3.5 3.0 Yield 2.5 2.0 1.5 1.0 0.5 NOV NOV NOV NOV 2009 2010 2011 2012 Source: Bloomberg, as of November 30, 2012. Past performance is not guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Figure 2: Sector spreads (bps) Global HY corp EMD corp (USD) EMD govt (USD) Global IG corp US MBS 1000 900 800 700 600 500 Spread 400 300 200 100 0 -100 NOV NOV NOV NOV 2009 2010 2011 2012 Source: Bloomberg, as of November 30, 2012. Past performance is not guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. 3
  4. 4. Market outlook Western Asset continues to believe that the global The continuing fiscal drag in Europe remains a economy will expand at a moderate pace in 2013. headwind to global growth, as it will impact net Although the risks of a weaker outcome remain exports from the US and Asia and remain a source meaningful, the monetary policy response and of risk for markets. But even here, politicians’ and the major central banks’ determination to support central bankers’ policy responses are increasingly growth and financial markets should continue to coordinated and targeted at reducing systemic risks support the global economy. Moreover, recent to the eurozone. Despite the removal of a number data from the US and China show encouraging of political risks recently, valuations in peripheral signs of recovery. While the US economy faces eurozone markets now offer less of a cushion for a number of headwinds, the manager believes that the considerable policy implementation and other growth will remain positive but below potential. economic, social and political risks that remain, in Support will come from the ongoing recovery particular related to Greece and Spain. Although in housing and highly accommodative monetary Greece recently received a “stay of execution” from policy that explicitly links future policy action to its public sector creditors, and Spain has begun a recovery in the labor markets and the economy. the painful task of recapitalizing its broken banks, the continued narrowing in economic divergence The manager believes that there is scope for between the eurozone core and the periphery a modest acceleration in China’s economy next year, (as a result of pronounced weakness in Germany with the help of policy measures and lower inflation. and France), raises the risk of “bail-out fatigue” by Chinese authorities have considerable flexibility to northern European politicians in 2013, as growth continue to support the economy with both fiscal and deficits start to meaningfully deviate from and monetary policy. Brazil’s economy has suffered targets set this year. a setback recently but is also poised for firmer growth, as interest rates have been cut sharply in With less pressure from markets in the wake of the recent quarters and government policy is focused ECB’s recent policy actions and while the manager on improving the country’s infrastructure. The remains encouraged by Italy’s progress in its outlook for Mexico is also positive, given the structural reforms, risks remain of slower progress in prospects for the new administration to address addressing the structural imbalances at the heart of labor market, energy sector and fiscal reforms. the eurozone crisis. The ECB’s ability to intervene in peripheral eurozone bond markets is made even more critical by the approach of Italian elections next spring, German federal elections in September 2013, doubts over the implementation of the banking union (which could eventually help sever the corrosive link between banks and sovereigns) and of the fiscal compact.4
  5. 5. Bond sector total returns5 (%) “ 1-month 12-months Barclays European Treasury Index 1.5 14.5 Barclays European Corporate Index 0.9 15.4 Barclays Pan-European High Yield (Euro) Index 1.9 28.4 Lower credit quality Barclays Sterling Gilts Index 0.8 5.2 and financial issues, Barclays Sterling Corporate Index 1.3 18.2 especially in Europe, Barclays Pan-European High Yield (Sterling) Index 2.2 31.2 again led advances.” Barclays U.S. Treasury Index 0.5 3.4 Barclays U.S. Agency Mortgage Backed Securities (MBS) Index -0.2 3.2 Western Asset Barclays U.S. Corporate Index -0.2 12.2 Barclays U.S. High Yield Index 0.8 17.1 JPMorgan Emerging Markets Bond Index Plus (EMBI+) 1.7 18.5 JPMorgan Corporate Emerging Market Bond Index (CEMBI) Broad Composite 0.3 15.2 JPMorgan Government Bond Index — Emerging Market 1.4 12.6 (GBI-EM) Global Diversified Composite Source: Bloomberg, as of November 30, 2012. Past performance is not guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Investors cannot invest directly in an index.5 The Barclays European Treasury Index is the Treasury component of the Euro Government index, which is part of the Barclays Capital Euro-Aggregate Index. The Barclays Euro-Aggregate Index consists of bonds issued in the euro or the legacy currencies of the 16 sovereign countries participating in the European Monetary Union (EMU). All issues must be investment grade rated, fixed-rate securities with at least one year remaining to maturity. The Euro-Aggregate Index excludes convertible securities, floating rate notes, perpetual notes, warrants, linked bonds, and structured products. German Schuldscheine (quasi-loan securities) are also excluded because of their trading restrictions and unlisted status, which results in illiquidity. The country of issue is not an index criterion, and securities of issuers from outside the Eurozone are included if they meet the index criteria. The Barclays European Corporate Index is the Corporates component of the Euro-Aggregate Credit index, which is part of the Barclays Euro-Aggregate Index. The Barclays Pan-European High Yield (Euro) Index covers the universe of fixed-rate, sub-investment-grade debt denominated in euros or other European currencies (except Swiss francs). This index includes only euro-and sterling-denominated bonds, because no issues in the other European currencies now meet all the index requirements. To be included, the bonds must be rated high-yield (Ba1/BB+ or lower) by at least two of the following ratings agencies: Moody’s, S&P, Fitch. If only two of the three agencies rate the security, the lower rating is used to determine index eligibility. If only one of the three agencies rates a security, the rating must be high-yield. Bonds must have at least one year to maturity and an outstanding par value of at least EUR50 million. The index does not include non-rated bonds, and it excludes debt from entities in countries that are designated as emerging markets. The Barclays Sterling Gilts Index is the Gilts component of the Barclays Sterling Aggregate Bond Index. The Sterling Aggregate Index contains fixed-rate, investment-grade Sterling-denominated securities. Inclusion is based on the currency of the issue, and not the domicile of the issuer. The principal asset classes in the index are Treasuries (Gilts), Corporates, Government Related and Securitised. Securities in the index are all eligible for the Pan-European Aggregate and Global Aggregate indices. The Barclays Sterling Corporate Index is the Corporates component of the Barclays Sterling Aggregate Bond Index. The Barclays Pan-European High Yield (Sterling) Index is the sterling component of the Pan-European High Yield Index. The Barclays U.S. Treasury Index is the U.S. Treasury component of the U.S. Government index, which is part of the Barclays U.S. Aggregate Bond Index. The Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. The Barclays U.S. Agency Mortgage Backed Securities (MBS) Index is the U.S. MBS component of the U.S. Aggregate index. The MBS Index covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The Barclays U.S. Corporate Index is the corporate component of the U.S. Credit index, which is part of the Barclays U.S. Aggregate Bond Index. The Barclays U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt, including corporate and non-corporate sectors. Pay-in-kind (PIK) bonds, Eurobonds, and debt issues from countries designated as emerging markets are excluded, but Canadian and global bonds (SEC registered) of issuers in non-emerging market countries are included. Original issue zero coupon bonds, step-up coupon structures, and 144-As are also included. The JPMorgan Emerging Markets Bond Index Plus (EMBI+) is a total return index that tracks the traded market for U.S. dollar- denominated Brady and other similar sovereign restructured bonds traded in the emerging markets. Please note an investor cannot invest directly in an index. The JPMorgan Corporate Emerging Market Bond Index (CEMBI) Broad Composite tracks USD denominated debt issued by emerging market corporations. The JPMorgan Government Bond Index — Emerging Market (GBI-EM) Global Diversified Composite tracks local currency bonds issued by Emerging Market governments. 5
  6. 6. What should I know before investing The opinions and views expressed herein are subject to change and are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice All investments involve risks, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Diversification does not assure a profit or protect against market loss. Yields represent past performance and there is no guarantee they will continue to be paid. Fixed income securities are subject to interest rate and credit risk, which is a possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. As interest rates rise, the price of fixed income securities falls. Foreign securities are subject to the additional risks of fluctuations in foreign exchange rates, changes in political and economic conditions, foreign taxation, and differences in auditing and financial standards. These risks are magnified in the case of investments in emerging markets. Mortgage-backed securities involve additional risk over more traditional fixed-income investments, including: interest rate risk, implied call and extension risks; and the possibility of premature return of principal due to mortgage prepayment, which can reduce expected yield and lead to price volatility. U.S. Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities. A credit rating is a measure of an issuer’s ability to repay interest and principal in a timely manner. The credit ratings provided by Standard and Poor’s, Moody’s Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest). Please see,, or for details. This document is for information only and does not constitute an invitation to the public to invest. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. Please note that an investor cannot invest directly in an index. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors. The information in this document is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason nor any officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this document or its contents. 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Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc. Investors in Canada: This document is provided by Legg Mason Canada Inc. Address: 220 Bay Street, 4th Floor, Toronto, ON M5J 2W4. Legg Mason Canada Inc. is affiliated with the Legg Mason companies mentioned above through common control and ownership by Legg Mason, Inc. Investors in Australia: This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) (“Legg Mason”). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client’s professional advisers. This material is not for public distribution outside the United States of America. © 2013 Legg Mason Investor Services, LLC, member FINRA, SIPC. 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