US

Although the United States just announced that its 2020 Q2 GDP fell 32.9% QoQ annualised, which was the largest drop on record, several tech giants such as Facebook, Apple, Amazon, and Google’s parent company Alphabet still announced earnings beats, driving the tech sector up. Over the past 5 days ending Thursday, the S&P 500 and the NASDAQ rose 0.33% and 1.21% respectively, while the Dow fell 1.27%. The covid epidemic in the US remains severe, the number of covid deaths in Texas reached a new record high. After the interest rate meeting, Fed Chairman Jerome Powell pointed out that more fiscal policies are needed to stimulate the economy, and the idea of hiking rates is completely off the table. On the other hand, US President Trump tweeted the idea of ​​postponing the November elections, but congressmen from both parties opposed the idea, and he does not have the relevant power to actually postpone the elections. Finally, it is worth mentioning that the US dollar index has fallen and reached its lowest level since May 2018, while the gold price has hit a record high. The US will be releasing the latest employment figures, market expects that the Nonfarm Payrolls in July will fall to 1.635 million.

Europe

European stock markets slightly underperformed. The UK, French, and German equities fell between 3.57% and 5.52% over the past 5 days ending Thursday, lagging behind global markets. As the epidemic continued to ravage across the globe, the European Central Bank required European banks to suspend dividends and stocks buybacks before the end of 2020 in order to maintain financial stability. Germany’s GDP fell by 10.1% in 2020 Q2, while the Eurozone’s GDP fell 12.1% QoQ, both setting new record lows. The Eurozone consumer price index in July rise 0.4% YoY. The Eurozone retail sales data will be announced next week.

China

A-shares performed better this week, with the CSI 300 Index rising 4.2% over the week; Hong Kong stocks were slightly worse, falling 0.45% over the same period. China announced satisfactory industrial profits in June, which rose 11.5% YoY. As for the official manufacturing index in July, it came in at 51.1, which was higher than the previous figure of 50.9; However, the July non-manufacturing index was 54.2, slightly lower than last month’s figure of 54.4. On the other hand, the HKD continued to show strength, and the HKMA intervened in currency market twice on Thursday, selling more than 4.6 billion HKD in total. China will announce its July data on imports and exports, foreign reserves, and Caixin manufacturing PMI next week.

3 main ways to invest in bond market

There are three mainstream instruments to invest in bond market today, namely direct bonds, bond funds and bond ETFs. Direct bond refers to directly holding the bonds issued by an entity, corporate or sovereign. Holding direct bonds is basically equivalent to being a creditor of the company, the bond holder has the right to directly claim the principal from the issuing company. One might be more familiar to instruments like the “i-Bond”, which is a retail bond issued by the Hong Kong Government through the Hong Kong Stock Exchange.

As for bond funds, they are funds that invest in the bond market, usually holding direct bonds. Since bond funds can gather more capital, they can hold more bonds in its portfolio, achieving better risk diversification. In addition, the bond funds also have different investment objectives, some invest by region, others by type or theme.

The last of the bunch is bond or fixed income ETFs. For those who are unfamiliar with the term “ETF”, its long-form is Exchange Traded Funds, ETFs tend to hold securities with the same composition as its corresponding index to track the performance of the index. One of the biggest advantages of using ETFs is the existence of the secondary market, so you can buy or sell them on the listed exchange. The Hong Kong Stock Exchange listed Tracker Fund (2800) is one of the best-known equity ETFs that tracks the performance of the Hang Seng Index. Similar to the equity ETFs, fixed income ETFs operate in the same way, holding a basket of bonds, instead of stocks, to track its bond index. However, currently there are less than 20 bond ETFs listed on the Hong Kong Stock Exchange.

Minimum investment amount

First off, the minimum investment amounts can differ a lot. The minimum investment amount for direct bonds is relatively higher. For common corporate bonds not issued through the Hong Kong Stock Exchange and denominated in US dollars, the usual minimum investment face value is USD 200,000, with a very minority of them at USD 100,000. For HKD denominated bonds, the minimum investment face value would be HKD 1 million. If you compare it to HK listed stocks, where the minimum investment amount mostly ranged between Hong Kong dollars of several thousand or several tens of thousands, the entry barriers for investing in direct debt is much higher. Of course, the barriers to entry for retail bonds issued on the Hong Kong Stock Exchange could be lower, e.g the minimum investment amount for “i-Bond” is only HKD 10,000.

Barring retail bonds issued on the Hong Kong Stock Exchange, the entry barriers for bond funds and bond ETFs are relatively lower. Take bond funds as an example, for fund investment in retail banks, the minimum investment amount for a one-off investment ranges from around HKD 10,000 to HKD 50,000. As for the bond ETFs, the ones traded on the Hong Kong Stock Exchange also have a similarly low entry barrier, with the minimum lot averaging a few thousand HKD, which makes it one of the less demanding tools for novice investors.

Risk diversification

Secondly, the risk diversification levels are different. Direct bonds are only single bonds; while bond funds and bond ETFs hold a basket of bonds, with the number ranging from tens to hundreds of bonds, so they tend to achieve better risk diversification. Of course, investors could design a bond portfolio to achieve diversification in theory, but the investment amount of this approach will be much larger. As mentioned above, a straight bond would require a minimum investment amount of around HKD 1 million, a bond portfolio of 100 bonds would require around HKD 100 million, whereas bond funds or bond ETFs would only need a minimum of a few thousand HKD.

Maturity

The third point of focus is maturity. Most direct bonds have a clearly defined maturity, as long as there is no default or other special circumstances, investors can expect to receive the principal on the bond maturity date. On the contrary, bond fund investors could not predict the amount received at the time of redemption. As there is no maturity date, the bond fund will continue to reinvest the principal of its matured bonds. The net asset value of the fund changes daily, although investors can gain from the dividend pay-outs, there is no guarantee of a price gain at the time of redemption. Bond ETFs are essentially the same as a bond fund and it is exposed to the same risks as a bond fund.

Liquidity

The last point of focus the difference in liquidity. In terms of transaction speed, bond ETF is the fastest, a transaction can be done in mere seconds. In addition, trading on the Hong Kong Stock Exchange system, although it takes two trading days (commonly known as T+2) for cash settlement, investors could buy other securities listed on the Hong Kong Stock Exchange immediately, using the funds from selling the bond ETF. This is also known as receivable funds, which can be used for trading before the actual settlement date. In addition, issuers are usually required to bid based on the value of the investment vehicle, so the liquidity risk is relatively low with a tighter bid-ask spread.

In contrast, although direct bonds can also be traded in the secondary market, the selling amount is not usable before the settlement date, unlike receivable funds which can be used for trading on the Hong Kong Stock Exchange. Banks or other financial institutions usually need at least one working day to settle the sold amount. More commonly, bonds are traded on the OTC market, where they might be thinly traded, having sparse bids in the market, which gives rise to a greater liquidity risk. Even if there are open bids, the bid-ask spread might be rather large.

Bond funds are fundamentally different in liquidity terms, as transactions are not conducted in the secondary market, but only via subscriptions and redemptions between investors and the fund companies. Barring any special circumstances, the subscription and redemption of open-end bond funds should 100% be done, so the liquidity is quite adequate. But one should also note that you would not know the actual unit price for subscription and redemption, which is only known after the transaction, and the whole redemption process often takes two working days.

After comparing the three instruments, you may have a deeper understanding of investing in the bond market. Next up, we would further look into bond or instrument selection, and determine which bonds would best benefit from a given situation.

United States

Early trials of numerous covid vaccines showing positive results, coupled with a slight slowdown in the spread of the second wave in the US, the S&P 500 hit a new record high during the week. However, triggered by poor employment data, investors became more concerned about a slowdown in economic recovery. US equities fell on Thursday, wiping out gains over the past few days. The total number of covid cases worldwide has exceeded 15.5 million, of which the US accounted for more than 4 million. Trump even announced the cancellation of the Republican Party conference in Florida. In terms of data, the number of jobless claims in the US unexpectedly increased to 1.416 million, above the market expected figure of 1.3 million, this news had a negative impact on the stock market. Next week, the US will hold an interest rate meeting. The preliminary 2020 Q2 GDP will also be announced, market expects a QoQ decline of 34% annualised.

Europe

European stock markets have not seen much movement in the past few days. The UK, French, and German stock markets just fluctuated over the past 5 days ending Thursday. Earlier, EU leaders finally reached an agreement over the 750 billion Euro Recovery Fund. This fund consists of grants totalling 390 billion euros and an additional 360 billion euros in low-interest loans. In terms of economic data, the Eurozone consumer confidence index in July unexpectedly fell to negative 15, lower than the June figure of negative 14.7, the market originally expected it to further improve to the negative 12 level. Next week, Europe will announce the 2020 Q2 GDP, June unemployment data, and the July consumer price index.

China

Sino-US relations grew tenser by the day, gradually reversing the market's optimistic sentiment. The Shanghai and Shenzhen stock markets went down on Friday and erased gains over the week. The CSI 300 Index fell by 0.86% this week; the Hang Seng Index also recorded a 1.53% decline. The Hang Seng Indexes Company announced earlier that the new Hang Seng TECH Index, described by many as the "Hong Kong NASDAQ", will be launched on July 27, the announcement pushed the related technology stocks up. However, as tensions build between China and the US, market sentiment deteriorated, and the overall stock market fell. China will release data on June industrial profits, and the official manufacturing PMI in July next week.

Seizing Investment Opportunities in Bond Market
Firstly, there is the risk of the economic recession and heightened volatility in the equity market. By investing in the bond market, investors can diversify risk, and potentially reduce the volatility in the investment portfolio. Secondly, investors see the US entering a rate cut cycle. With rates going further lower, bonds will likely gain via price appreciation.

Mixing asset classes to improve risk-adjusted returns
Regardless of the extent of recession and the rate cut cycle, allocating a portion of the portfolio to bonds likely achieves the two goals above. First off, let’s see how investing in bonds can bring risk diversification to the portfolio. Traditionally, the correlation between the performance of bonds and stocks is lower than that of other assets, even showing negative correlation at times. Take the Bloomberg Barclays US Treasury Bond Index and the S&P 500 Index as an example, as at the end of June 2019, the 30-day correlation coefficient between the two is -0.44, out of a range of -1 to +1. A negative correlation means that when one asset falls, the other tends to rise. Thus, when the equity market crashes, bond prices will likely see gains simultaneously, which could hedge excess volatility in the portfolio. In addition, bear in mind that both bonds and stocks generate total return via coupons and dividends. Over a longer timeframe, investing in a negatively correlated hybrid portfolio will likely generate higher risk-adjusted returns.

Investment opportunities with rate cut expectations
Next, we will dive into why rate cuts in the US benefit bonds. Generally speaking, changes in the US interest rates are decided by the Federal Reserve adjusting the monetary policy, which guides market rates by limiting the upper and lower bounds of the local bank rates. Short-term rates are more sensitive to changes in the Fed fund rates, when the Fed cuts interest rates, short-term market interest rates tend to fall; long-term interest rates on the other hand are also affected by other factors, positively correlated to factors such as economic growth and inflation expectations. When the expected future investment return or inflation rate is higher, the market would require a higher interest return before they are willing to lock the funds in bonds. Historically, U.S. Treasury interest rates tend to fall in the rate cut cycles and rise during the rate hikes, as the central banks will implement interest rate cuts when growth is slowing, long-term interest rates often move in line with the interest rate cycles.

Falling interest rates makes bonds attractive
So how exactly is changing interest rates related to bond prices, one might have heard that the two move in opposite direction. When market interest rates rise, bond prices fall, and vice versa. While the gain or loss in bond prices can be calculated, to further simplify it, investing in bonds means you give up the potential return of the deployed capital if it was invested in other assets, which is the opportunity cost. Given a fixed coupon rate of the bond, when the market interest rate (floating rate) rises, the opportunity cost will rise, the attractiveness of holding this bond will decrease, the market will require this bond to provide a higher interest rate to compensate for the lost opportunities, which causes the bond price to fall; on the contrary, when the interest rate falls, the market would ask for a lower bond interest rates, existing bonds will become more attractive. Therefore, Fed rate cuts tend to be beneficial to bond prices.

All in all, investing in bonds on one hand improves the risk-adjusted return of the investment portfolio; on the other hand, it provides an opportunity to capture gains from potential central bank rate cuts. We shall look into the details of bond investment options and any other important matters in the next session.

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Entering the third quarter, as global concerns over the epidemic gradually die out, bonds became a less attractive option. Given the current low risk free rate, even with a widening credit spread we can still only earn limited return, unless we venture in the higher yielding bonds on the riskier side.

Therefore, one should be more selective in choosing bond names, with more emphasis on the credit quality itself, and eyeing for better opportunities when they arise. Possible yield enhancing options include new fallen angel bonds, which often give rise to one-off opportunities; specific company news regarding market events could also give rise to unique opportunities to further enhance yield without overly compromising risk control in the portfolio. Simply put, for investor investing in bonds, bear in mind the importance of quality when seeking risk diversification, while shorting duration when seeking extra yield.

US

Although the global covid epidemic is still severe, positive news from vaccine research progress, together with surprisingly good US corporate earnings pushed US equities upwards. Over the past 5 days ending Thursday, the S&P and the Dow rose 2% and 4% respectively, while the NASDAQ slightly retreated 0.7%. According to US pharmaceutical company Moderna, the clinical results of its covid vaccine showed progress, with all patients producing antibodies after the injection, the news lifted spirits in the investment market. On the other hand, the latest corporate earnings period for US equities have just started. Among the 40 companies that have announced corporate earnings, more than 80% beat market expectations. In particular, more than 90% of reporting banks and financials beat analyst estimates, the overall results were fairly satisfactory. In addition, the US House of Representatives Speaker Nancy Pelosi mentioned that the Congress will likely pass another epidemic relief bill in the next few weeks, further improving market sentiment. The US will announce the Markit Manufacturing PMI next week.

 Europe

European equities performed well over the past 5 days ending Thursday, the UK, French, and German equity indexes all rose more than 3%. The European Central Bank (ECB) kept interest rates and monetary policy unchanged after the interest rate meeting. ECB chair Lagarde said that the recovery speed and scale in the region remained very uncertain, so the ECB might need to fully utilise the Pandemic Emergency Purchase quotas. On the other hand, the European Union will hold a leaders’ summit during 17-18 July and discuss the 750 billion Euro economic recovery plan, Lagarde expects the EU Recovery Fund to be approved. The Eurozone will announce the Markit Manufacturing PMI and Consumer Confidence Index next week.

China

The China and Hong Kong markets saw large fluctuations over the week, the A-share market in particular experienced a sharp correction after an earlier surge, surprising markets. The CSI300 index reached a 5-year high of 4800 points at one point but subsequently fell, the HSI also retreated to the 25,000 level. As the total margin balance in China increased sharply and was close to 1.4 trillion yuan, both the China Securities Regulatory Commission and the China Banking and Insurance Regulatory Commission voiced concerns over off-site funding and indiscriminately increasing leverage, speculation in the market subsequently cooled. As for economic data, China's latest 2020 Q2 GDP beat market expectations, recording a YoY growth of 3.2%, bouncing back from the contraction of 6.8% in Q1. China will announce the LPR interest rate next week.

The epidemic continued to spread across emerging markets, with major EM economies like Brazil, Russia and India claiming the next 3 places for total covid cases after the US, yet local governments still continued to proceed with their original reopening plans. With the second wave outbreak underway, one might be concerned over its economic impact on the recovering economy. As repeatedly mentioned, with the epidemic as an example, emerging markets will continue to face extended external risks, which would serve as the main concern over investing in the region.

Betting on a gradual recovery in the global economy, emerging markets pose as a more attractive alternative with stronger rebound potential, considering the developed markets’ higher valuation. If the market sentiment continues to improve and the epidemic situation does not significantly worsen, we could possibly see EM outperform DM in the short to mid-term. Among emerging markets, we continue to see Asia markets as a better option over Latin America, prioritizing the Vietnam market in particular for its stronger secular growth.

The epidemic situation stayed relatively steady. Even though there are sparse cases in mainly in the metropolitan regions like Tokyo, the government saw limited concerns over another major outbreak, reopening continued and economic activities gradually picked up. However, with the pandemic ongoing on the global scale, key sectors like tourism and retail continued to suffer, May tourist figures even logged a staggering 99.9% drop YoY.

While the investment market should continue to receive support from the Bank of Japan, as outlined by weak leading economic indicators, the real economy is not expected to significantly improve in the short to mid-term. Thus, we will continue to take a neutral view over the market.

With that out of the way, Brexit matters are finally back on the table. Currently, the negotiations are in a deadlock, as both sides have yet to reach consensus on several key issues including fisheries and court matters. With the transition period not extending, corporations are worried that there will be a no-deal Brexit as both the Prime Minister Boris Johnson and the Bank of England suggested.

Economically, Europe is still in limbo. Despite the continued uptrend, global demand remains far from a full recovery, various indicators still show a contracting local economy. Disregarding the limited positive signs, fundamental weakness and Brexit concerns should continue to haunt the investment market, we would not suggest significant investment in the region.