(Bloomberg) — Forget the stock market or private credit. Fixed income will outpace other asset classes after “a generational reset of bond yields higher,” according to one of the world’s largest bond managers, Pacific Investment Management Co.
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“Active fixed income securities are well positioned to perform if there is no recession on the secular horizon and to perform even better if there is,” wrote Richard Clarida, Andrew Balls and Daniel Ivascyn of Pimco in their outlook published Tuesday. As prices rise and inflation falls, they expect bonds to become even more attractive than cash.
Since the start of the year, bond markets have posted modest losses, compared with a rise of around 10% for major US equity benchmarks. Many fund managers have been caught off guard by calls to buy government bonds from a still-resilient U.S. economy. The $147 billion Pimco Income fund, managed by Ivascyn, has climbed 7.8% over the past 12 months and is up 1.7% so far in 2024, outperforming about 80% of its peers .
With an investment horizon of the next three to five years, the $1.8 trillion bond manager said active investors can build portfolios yielding about 6 to 7 percent “without taking on significant interest rate risk , credit or illiquidity”.
This time is different as high-quality bond benchmarks – including Bloomberg US Aggregate and Global Aggregate – offer yields of 5% or more. “Starting returns are highly predictive of bond returns over a multi-year horizon,” they said.
“Markets do not appear to be pricing in significant recession risk, meaning bonds may be a cheap way to hedge that risk,” they added.
The asset manager warned of “the rapid growth of private floating rate markets which may not have been tested in previous default cycles”, and said it increases “the risk of development excess in areas such as technology and direct lending to high-potential companies. leverage and lower credit scores.
Apparently tight stock valuations are supportive for bonds, according to the Newport Beach, Calif.-based fund manager. The debate over the Fed’s neutral policy rate – a level that neither stimulates nor slows the economy – also offers “new opportunities for bond investors, as yields today already incorporate a cushion in the form of positive real rates and term premium”.
The bond market is currently positioned at a neutral rate close to 4%, while Pimco aligns more closely with the Fed’s 2 to 3%, once inflation returns close to the target set by the banks power stations.
Read the QuickTake: What is the Fed’s “neutral” rate? Why is it important?
Still, the asset manager remains cautious about the U.S. and global fiscal outlook and the possibility that longer-term returns will lag the performance of shorter-term benchmarks. In the U.S. market, Pimco sees value in five-year bonds as longer-dated Treasuries currently trade at similar levels but carry higher interest rate risk.
The authors reiterated their recent warnings about the potential underperformance of longer-term debt relative to U.S. budget deficits. And November is unlikely to change that, Pimco said. “Budget deficits will likely remain near historic highs regardless of the election outcome. »
On the Treasury’s “tantrum” last October, when yields on the benchmark 10-year bond hit 5%, triggered by concerns over debt issuance, they said : “Our baseline scenario is not a sudden financial crisis, but recurring episodes of market volatility when attention turns to public finances. problems.”
Other things to consider for investors over the next five years include:
Global yields in developed and emerging markets “have returned to attractive levels,” while “many economies outside the United States face more fragility while benefiting from better starting fiscal conditions, both favorable for bonds “.
The potential for more volatile inflation trends favors holding Treasury Inflation-Protected Securities (TIPS), commodities, and real assets because they offer “inflation-hedging properties and real rates higher than pre-pandemic levels.”
Expectations of government support through rate cuts and increased spending amid a future economic slowdown “are even more irrelevant today.” This should fuel further volatility.
Central bank bond purchases are less likely to resume during an economic downturn because “the financial pressure of maintaining large portfolios of securities, where funding costs exceed the returns on those assets, becomes increasingly more apparent.”
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