Our fixed income team has been advocating an overweight position in the investment grade financial sector relative to non-financials within the U.S. fixed income market. But what about outside of the U.S?
T he U.S. economy still has several years left to delever but the worst is past. Meanwhile, the Australian deleveraging cycle is just starting, while Canadian debt loads should peak soon. The relatively advanced stages of the deleveraging cycle and the recovery in the U.S. housing market are important factors that support our preference for U.S. Financials compared with those in Australia and Canada.
In the U.S., the peak in doubtful loans occurred about two years after the peak in overall leverage. If we assume approximately the same lag for the commodity countries, Australian banks are beginning to feel the pinch, and Canadian banks should soon.
If house prices fall while consumers are deleveraging, growth would falter and banks balance sheets would worsen. On the margin, these trends are negative factors for credit quality and for Financials spreads in Canada and Australia. Still, bad debt levels are unlikely to spike in these countries and bond markets have been unfazed by the recent rating downgrades.
Apart from being relatively vulnerable to deleveraging factors and housing market weakness, these smaller markets offer no yield advantage. As a result, our Global Fixed Income Strategy service recommends focusing the Financials vs. Non-Financials overweight in the U.S. and a neutral allocation between these two sectors within Canadian and Australian markets.