The promise of huge returns and artificial intelligence has lured investors and meme stock speculators to the stock market in recent years. But for the bond market, it’s a different story.
After keeping interest rates near zero for nearly a decade after the financial crisis and again during the coronavirus pandemic, the Fed began raising rates sharply in March 2022 to combat inflation. The relationship between bond prices and yields as the federal funds rate changes.
It’s been 46 months since the bond market last hit a record high, and the Bloomberg Composite Bond Index is down about 50% from its peak in July 2020. But with bonds finally offering stable yields, some of the world’s top fixed-income investors believe this is the best time to invest in bonds in a generation.
“This is a very, very attractive entry point,” said Anders Persson, chief information officer for fixed income at global asset manager Nuveen. wealth in a recent interview. “I mean, basically, as we all know, the yields are the most attractive we’ve seen in over 15 years.”
As Rick Rieder, chief information officer of BlackRock’s global fixed income and head of the asset allocation team, pointed out, the Fed’s rate hike essentially “brings fixed income back into fixed income.”
“You can create a portfolio that yields close to 7% and has pretty modest volatility. It’s been decades since you’ve been able to do that,” he told wealth last month.
With investors locking in those yields, bond prices could also rise when the Federal Reserve begins cutting interest rates later this year or next year. These bond market experts say this is a great opportunity for stable income and price appreciation.
Why bond investors are bullish
Persson and Reed, who have about $2.8 trillion in assets combined, about 23 times the value of each NBA team, are bullish on bonds, even though PIMCO co-founder and “bond king” Bill Gross ) warned that without interest rate cuts to boost prices, bond market investors will simply “cut coupons,” or collect interest income from yields.
These coupons are very attractive in many sub-industries.
“When you think about 6% for broader fixed-income loans, 7% for senior loans, 8% for high-yield loans and almost 10% for senior loans, those entry levels have been really attractive from a historical perspective. ,” emphasizes Nuveen’s Persson.
Historically, he added, there has been a high correlation between fixed-income investors’ future total returns and the high yields they achieved when they started investing. To this point, a chart of annual returns from NYU Stern School of Business shows that bonds tend to outperform after the peak of the Fed’s rate hike cycle, when yields are higher.
For example, after then-Federal Reserve Chairman Paul Volcker raised interest rates to a peak of 19% in 1981 to combat runaway inflation, corporate bonds provided investors with returns of more than 15% for five consecutive years. Return. They also outperformed stocks in five of those years.
Reid also said that there is huge potential for bond prices to appreciate because interest rate cuts may begin once data finally confirms that the Fed has defeated inflation.
Persson expects one or two interest rate cuts this year and said the Fed will have to cut rates significantly if the economy starts to collapse. “Then you get the total return, or capital appreciation, on that investment,” he told us wealthadding, “In most cases, you’ll see pretty healthy return potential over the next 12 months.”
There is also evidence that bonds could still outperform even if rates remain unchanged and the Fed remains in its current wait-and-see mode for longer than expected. Lawrence Gillum, chief fixed income strategist at LPL Financial, noted in a note to clients last summer that the Bloomberg Composite Bond Index performed well during periods when the Federal Reserve historically paused interest rate increases.
“Since 1984, after the Fed stopped raising interest rates, core bonds have been able to generate average 6-month and 1-year returns of 8% and 13%, respectively. Additionally, all periods have averaged 6-month, 1-year, and 3-year returns. Positive returns were generated across the range.
To Reid, that’s one reason why the current environment, where the Fed is stuck in hold mode, is a Goldilocks zone for fixed-income investors. “You have this incredible gift that because inflation remains where it is, we’re buying credit assets cheaper than they should be,” he explained.
