Fixed Income

A large swath of the institutional asset-allocation world is engaged in the sometimes dangerous, binary game of “stocks versus bonds.” Although the 2022 bond debacle caused relatively mild damage to a massively overweight equity position, the bear markets of 2000-2002 and 2007-2009 produced losses for stocks versus bonds that exceeded 60%. 

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The 60/40 strategy is having a terrible year, and its failure to protect investors in the bear market prompted us to take a look at the history and theory of the 60/40 guideline. We offer an early preview of the study, with a focus on 2022’s abysmal year-to-date returns.

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

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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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Over the past few months we’ve seen the largest high yield bond fund outflow since 2000. We will exercise patience for now and wait for a better entry point.

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Despite the exodus from all bond classes in the last few months, longer term demand for safe spreads is likely to remain strong and investment grade issuance has dropped significantly.

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The recent upside breakout in the U.S. 10-year yield was successful, and it appears interest rates will remain in the new higher range for now. But what are the short-term implications of higher U.S. Treasury rates on asset allocation decisions?

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First, let us be thankful February 29th only occurs every four years. No, we haven’t done a historical performance analysis of past leap year extra days, but you can be certain somebody now has. Whatever, it was a bad end to February 2008.

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Small Cap Stocks were hands down winners relative to large caps, while just edging out mid caps. This is the fifth consecutive year of small cap superiority.

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The U.S. economy still has considerable momentum, but there are now more signs of a slowdown ahead. Global economy is slowing down even more.

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Economy still has considerable momentum, but there are signs of a slowdown in the second half. Still expect further Fed tightening. Expect inflation rates of change to soon peak, then cool off in Q4.

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· Still expect one more rate hike due to rekindling of stock market enthusiasm, prospects of accelerating inflation, and reported wage inflation numbers understated.

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Despite weaker economic news, still expect Fed to bump rates up at least once more.

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Further Fed tightening to come…..Next few month inflation news likely to be scary.

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Strong economic news, and rising inflation trends make further Fed tightening almost a certainty.

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Strong economic news, and rising inflation trends make further Fed tightening almost a certainty.

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Yield curve inversion reflects supply/demand dynamics, expectations of further Fed tightening and unwinding of short strategies by speculators.

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