Bonds

The bond market bubble has popped, and forward-looking Treasury returns are no longer a disaster. We aren’t suggesting one pile into them with yields near 4% and inflation around 8%, but we think they have suffered a much more substantial de-rating than large-cap stocks.

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Investors looking to diversify away from the U.S. interest rate environment and/or the domestic business cycle may wish to consider Emerging Market bonds, an asset class with lower correlations to the U.S. Agg. Bond Index. EM bond investors can choose between several investment attributes to find the risk / return profile with which they are most comfortable. This study surveys the investment tradeoffs offered by each sub-category, as defined by ETFs focused on each particular asset class.

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The U.S. Aggregate Bond Index lost 3.8% in April, bringing its year-to-date return to an agonizing -9.5%. The realization that bonds can lose big money, combined with the outlook for stubbornly high inflation and continued rate increases, is nudging bond investors to consider a wider scope of alternatives.

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As credit spreads widened, something rather unusual happened: investment grade Corporate bonds performed far worse than High Yield bonds.

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To use the old cliche' for lack of a better term, the bond market backed and filled in December.

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Hard-core statisticians might be disappointed to learn that the 140-ish inputs in our Major Trend Index (MTI)aren’t entirely “independent and uncorrelated.”

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Both the macro backdrop and price trend still point to narrower spreads ahead.

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The S&P 500 once again remains on the verge of a new bull market high, thanks in large part to the bubble in another asset class: Bonds.

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We would like to see a stabilization in oil prices before we turn favorable to Corporate credits. For now, we maintain a Neutral view on these bonds.

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Municipals reduced to “Neutral.” Near term risk of higher interest rates stemming from European side is too hard to ignore.

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While the collapse of Swiss government bond yields into negative territory was January’s bond market stunner, our “G7” composite 10-year government bond yield reached its own milestone when it closed the month below 1.0% for the first time in post-WWII history.

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High grade credit spreads were unchanged...Risk-on rally for high yield is getting to a mature stage...Tax advantage offered by munis make them attractive.

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Given the higher volatility and increased risk aversion, high grade credits are attractive as the negative relationship between rates and credit spreads dampens the volatility of this asset class.

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The thin liquidity likely magnified the move in both rates and credit spreads, but we continue seeing a friendly macro environment that supports high quality credits.

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We were surprised to see that all differentials ten years and longer are still below their respective 1926-to-date medians, indicating they still have the potential to keep moving towards historical median levels. We expect stocks to outperform bonds going forward.

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The renewed participation of credits in the risk asset rally is a welcome sign.

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We are encouraged by the narrower spreads in October as the feared divergence between credits and equity markets did not continue.

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U.S. Investment Grade Corporate Bonds: Favorable, U.S. High Yield Corporate Bonds: Neutral, U.S. Municipal Bonds: Neutral

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On the positive side, the fundamental picture is still healthy for most U.S. high yield issuers, and defaults are expected to be low. On the negative side, weakening inflation expectations is a divergence that bears close monitoring. We will exercise patience and wait for a better entry point.

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This is consistent with our overall cautious view on credits. Credit spreads continued narrowing despite higher volatility in the bond markets.

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