Supercharged returns and the promise of AI have drawn investors—and meme-stock speculators—to equity markets in recent years. But it’s been a very different story for the bond market.
After keeping interest rates near zero for almost a decade after the Great Financial Crisis and again during the COVID era, the Federal Reserve began aggressive rate hikes to fight inflation in March 2022. That led to a painful fixed-income bear market due to the inverse relationship between bond prices and yields (which move with the Fed funds rate).
It’s now been 46 months since the bond market last reached a record high, and the Bloomberg Aggregate Bond Index is down roughly 50% from that July 2020 peak. But with bonds finally offering solid yields, some of the world’s top fixed-income investors believe this is the best time in a generation to get into bonds.
“The entry point is just very, very attractive,” Anders Persson, CIO of fixed income at the global asset manager Nuveen, told Fortune in a recent interview. “I mean, basically, yields, as you know well, are the most attractive that we’ve seen in 15 plus years.”
As Rick Rieder, global CIO of fixed income and head of the asset allocation team at BlackRock, noted, the Fed’s rate hikes have essentially “put the fixed back into fixed income.”
“You can create a portfolio with a close to 7% yield with volatility that’s pretty moderate. It’s been decades since you’ve been able to do that,” he told Fortune last month.
After investors lock in those yields, bond prices could also rally when the Fed starts cutting rates later this year or next. It’s a golden opportunity for a mix of steady income and price appreciation, according to these bond market gurus.
Why the bond investors are bullish
Persson and Rieder—who are collectively responsible for roughly $2.8 trillion in assets, or about 23 times more than the value of every NBA team put together—are bullish on bonds even as PIMCO co-founder and “bond king” Bill Gross has cautioned that without rate cuts to boost prices, bond market investors will merely be “clipping coupons,” or collecting interest income from yields.
Those coupons are quite juicy in many sub sectors.
“When you’re looking at 6% or so for broader fixed income, 7% for preferred, 8% for high yield, and almost 10% for senior loans, those entry levels are really, really attractive from a historic basis,” Nuveen’s Persson emphasized.
He added that, historically, there’s a high correlation between future total returns for fixed-income investors and how high yields were when they began investing. To that point, NYU Stern’s annual return chart shows that bonds tend to outperform after peaks in the Fed’s hiking cycles (i.e. when yields are high).
Corporate bonds, for example, offered 15%-plus returns to investors for five straight years after then-Fed Chair Paul Volcker famously raised interest rates to a peak of 19% in 1981 to fight runaway inflation. And they outperformed stocks three out of five of those years as well.
Rieder also said there’s serious price appreciation potential in bonds because rate cuts are likely on the way once data eventually confirms the Fed has defeated inflation.
Persson, who is forecasting one or two rate cuts this year, said that if the economy starts to crack, the Fed will have to cut aggressively. “And then you get the total return aspect, or the capital appreciation side, of that investment,” he told Fortune, adding that “in most scenarios, you’re seeing a pretty healthy return potential here over the next 12 months.”
There is also evidence that bonds could still outperform even if interest rates stay where they are, with the Fed maintaining its current wait-and-see mode for longer than expected. In a note to clients last summer, LPL Financial’s chief fixed income strategist, Lawrence Gillum, noted that the Bloomberg Aggregate Bond Index has performed well during periods when the Fed has paused its rate hikes historically.
“Since 1984, core bonds were able to generate average 6-month and 1-year returns of 8% and 13%, respectively, after the Fed stopped raising rates. Moreover, all periods generated positive returns over the 6-month, 1-year, and 3-year horizons,” he wrote.
For Rieder, that’s one reason why the current environment, where the Fed is stuck in a holding pattern, is a Goldilocks zone for fixed income investors. “You have this incredible gift, because inflation is staying where it is, we’re getting to buy credit assets cheaper than we should be,” he explained.
This story was originally featured on Fortune.com
Source: finance.yahoo.com