Supercharged returns and the promise of AI attracted investors-and even-stock speculators…on the stock markets in recent years. But the situation is very different for the bond market.
After keeping interest rates near zero for nearly a decade following the Great Financial Crisis and again during COVID, the Federal Reserve began raising interest rates aggressively to combat inflation in March 2022. This led to a painful bear market in fixed income due to the inverse relationship between bond prices and yields (which move with the federal funds rate).
It’s now been 46 months since the bond market hit a record high, and the Bloomberg Aggregate Bond Index is down about 50% from that July 2020 peak. But while bonds are finally offering solid returns, some of the world’s biggest fixed income investors say it’s the best time in a generation to get into bonds.
“The entry point is just very, very attractive,” said Anders Persson, CIO of fixed income at global asset manager Nuveen. Fortune in a recent interview. “I mean, fundamentally, the yields, as you well know, are the most attractive we’ve seen in over 15 years.”
As Rick Rieder, global CIO of fixed income and head of the asset allocation team at black rockpointed out, the Fed’s rate hikes essentially “put fixed-rate securities back in favor of fixed-income securities.”
“You can create a portfolio with a return close to 7% with fairly moderate volatility. You haven’t been able to do that for decades,” he said. Fortune last month.
Once investors secure those yields, bond prices could also rise when the Fed begins cutting rates later this year or next. According to these bond market gurus, this is a golden opportunity for a mix of stable income and price appreciation.
Why bond investors are optimistic
Persson and Rieder — who are collectively responsible for about $2.8 trillion in assets, or about 23 times more than the value of every NBA team combined — are bullish on bonds, even though co-founder and PIMCO’s “bond king” Bill Gross warned that without rate cuts to drive up prices, bond market investors will only be “clipping coupons», or receive interest income on the returns.
These coupons are very juicy in many sub-sectors.
“When you look at about 6% for broader fixed income, 7% for preferred, 8% for high yield loans, and almost 10% for senior loans, those entry levels are really, really attractive from a historical point of view,” says Nuveen. Persson pointed out.
He added that historically there is a strong correlation between future total returns for fixed income investors and the level of returns when they started investing. At this point, NYU Stern annual performance table shows that bonds tend to outperform after the peaks of Fed hike cycles (i.e. when yields are high).
Corporate bonds, for example, offered investors returns of more than 15% for five straight years after then-Fed Chairman Paul Volcker raised interest rates up to a peak of 19% in 1981 to combat galloping inflation. And they also outperformed stocks three out of five years.
Rieder also said there is serious potential for bond price appreciation as rate cuts are likely once the data finally confirms that the Fed has beaten inflation.
Persson, who expects one or two rate cuts this year, said that if the economy begins to crack, the Fed will have to cut interest rates aggressively. “And then you get the total return aspect, or the capital appreciation aspect, of that investment,” he said. Fortuneadding that “under most scenarios, you see some pretty healthy return potential here over the next 12 months.”
It also appears 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 customers Last summer, Lawrence Gillum, LPL Financial’s chief fixed income strategist, noted that the Bloomberg Aggregate Bond Index had performed well during periods when the Fed had historically paused rate hikes.
“Since 1984, core bonds have been able to generate average 6-month and 1-year returns of 8% and 13%, respectively, after the Fed stopped raising rates. Additionally, all periods generated positive returns over the 6-month, 1-year, and 3-year horizons,” he wrote.
For Rieder, this is one reason why the current environment, in which the Fed is stuck in a holding pattern, is a Goldilocks zone for bond investors. “You have this incredible gift, because inflation stays where it is, we can buy credit assets cheaper than we should be,” he explained.
