Fixed income is back
IN Partnership with
Mark Lindbloom, portfolio manager at Western Asset Management Company, a specialist investment manager of Franklin Templeton, explains why fixed income offers compelling return potential
More
LAST YEAR was spectacularly volatile for all asset classes, including fixed income. By some accounts, 2022 was one of the worst years for bonds since the Great Depression, as the economy attempted to emerge from the unprecedented global pandemic, heightened geopolitical tensions, and the fast emergence of record-breaking levels of inflation globally. As a result, the Federal Reserve (and global central banks more broadly) embarked on its most aggressive interest rate-hiking cycle in a generation, with a focus on addressing historically high inflation. The intention of most central banks across both developed and emerging markets was to raise rates to fight rising inflation, but ultimately those efforts squeezed liquidity, resulting in relentless pressure across all risk assets.
This rising-rate environment created a new problem by derailing the traditional inverse correlation of high-quality bonds and risk assets, particularly equities. Headlines decried the “death of the 60/40 portfolio,” (i.e., 60 percent stocks/40 percent bonds), which also had its worst year on record. However, while bear markets are brutal, they do provide a benefit: restoring valuations.
Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 155 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers boutique specialization on a global scale, bringing extensive capabilities in equity, fixed income, multi-asset solutions, and alternatives. With offices in more than 30 countries and approximately 1,300 investment professionals, the California-based company has 75 years of investment experience and approximately US$1.5 trillion (approximately CAN$1.9 trillion) in assets under management as of March 31, 2022.
Find out more
nominal annual return on us bonds
50
“Today’s higher yields have opened up potential opportunities for investors to generate better returns, diversify portfolios, and lock in attractive income across the fixed-income spectrum”
Mark Lindbloom,
portfolio manager, Western Asset Management Company
The last year or so has undoubtedly been a daunting period to navigate. While most of 2022 was challenging, to say the least, for financial markets, given the negative returns for most asset classes, there has been some meaningful improvement and recovery over the last several months. Inflation pressures appear to be easing, and the Federal Reserve is likely near the end of its rate-hiking cycle.
For investors who are positioning portfolios based on the long-term disinflationary trend, and assuming COVID was a historic one-off, the perennial question of “Where can I potentially find yield?” remains. As mentioned earlier, the one benefit emerging in the aftermath of this rough patch is that bond yields and valuations have been restored – so investors are now much more likely to find opportunities for lower-risk yield. Simply stated, valuations in the fixed-income market have not been this attractive in a very long time. Of course, that’s a reflection of the enormity and pervasiveness of last year’s bear market. Not only did Treasury rates move higher, but spreads also widened in non-Treasury sectors. The starting point matters, and that’s what fuels much of our optimism for the fixed-income asset class at this time. More attractive valuations against a backdrop of falling inflation set the table for an attractive investment environment.
With valuations in better shape, inflation slowing, and volatility down, the case for fixed income today is very strong. Today’s higher yields have opened up potential opportunities for investors to generate better returns, diversify portfolios, and lock-in attractive income across the fixed-income spectrum.
Considering an even longer timeline, Shiller data dating back to 1870 confirms that 2022 was the worst single calendar year for US Treasury (UST) total returns and the first year of back-to-back negative total returns (along with 2021). We believe a third consecutive year of negative UST returns is highly unlikely. The rationale here is that in 2022 there was an unforeseen worldwide inflation shock that combined with an aggressive and rapid response by central banks globally. A repeat of this scenario is not expected given the magnitude of rate hikes already executed and increasing evidence of moderating global growth and inflation. What’s more, we believe this backdrop should support stable-to-lower yields and healthier bond returns.
Investors seeking enhanced income may also consider high-yield bonds. Since the start of 2022, high-yield bonds have more than doubled the income they pay and now compensate investors better against potential default risks (of the corporate issuers). Tighter credit conditions and a possible economic slowdown will not affect all companies equally, so it’s important to consider an active management approach to investing in high-yield bonds.
benefit from a better fixed-income starting point, with real rates positive across the curve. We haven’t seen this since the global financial crisis nearly 20 years ago, and it is all happening as inflation declines. The debate now is how fast and how far inflation can fall. But the key point is that the market now has some confidence that inflation is declining and will be contained. Given this environment, and the fact that this level of all-in yields hasn’t been seen for a decade, we believe investors should find fixed income to be very attractive.
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Turning challenges into opportunities
Making the case for fixed Income
Published 12 June 2023
“The debate now is how fast and how far inflation can fall. But the key point is that the market now has some confidence that inflation is declining and will
be contained”
Mark Lindbloom,
portfolio manager, Western Asset Management Company
40
30
20
10
0
-10
-20
Percent
1872
1882
1892
1902
1912
1922
1932
1942
1952
1962
1972
1982
1992
2002
2022
2012
Source: Rober Shiller, Bloomberg. As of 31 Dec 22
Long US Treasuries and Equities – Yearly Total Returns Since 1926
Equities (%)
60
40
20
0
-20
-40
-60
-40
Source: Ibbotson, Bloomberg, Equities represented by the S&P 500. Long US Treasuries represented by Bloomberg Long US Treasury Bonds. As of Dec. 31, 2022
-20
0
20
40
60
2022
The classic potential diversification benefit of fixed income has returned, with the traditional 60/40 investment strategy working again. The evidence of this can be seen in the sharp decline of bond yields in March 2023 (notably at the front end of the yield curve) due to heightened concerns over US and European banking system stability. This is one indication that stock and bond market correlations are normalizing, and fixed income’s historical diversification benefits appear to be back. For a much broader perspective, consider the correlations of US Treasuries to equities going all the way back to 1926. The following chart illustrates just how much of an outlier year 2022 was with respect to the traditional correlations.
The bottom line
Fixed income offers potential diversification benefits
Again, the combination of higher rates and wider spreads means that valuations were restored in a very meaningful way, ultimately improving the forward-looking prospects for fixed income. As a result, investors have the opportunity to
Fixed income offers compelling return potential
Western Asset’s view is that the inflation process, which has been declining, is ongoing but will be uneven and take time. But one thing is clear – both the US and global economies are moving decisively toward lower inflation rates, and fixed income should benefit as a result. Add to this the expectation that central banks will likely be pausing rate hikes, or even lowering rates. The culmination of these factors, as well as the diversification, income, and choice benefits discussed above, point to a very positive outlook for fixed income across the board.
Fixed income now offers investors more choice
Important legal information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market.
Commissions, trailing commissions, management fees, brokerage fees, and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.
Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.
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Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 155 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers boutique specialization on a global scale, bringing extensive capabilities in equity, fixed income, multi-asset solutions, and alternatives. With offices in more than 30 countries and approximately 1,300 investment professionals, the California-based company has 75 years of investment experience and approximately US$1.5 trillion (approximately CAN$1.9 trillion) in assets under management as of March 31, 2022.
Important legal information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market.
Commissions, trailing commissions, management fees, brokerage fees, and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.
Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.
Western Asset’s view is that the inflation process, which has been declining, is ongoing but will be uneven and take time. But one thing is clear – both the US and global economies are moving decisively toward lower inflation rates, and fixed income should benefit as a result. Add to this the expectation that central banks will likely be pausing rate hikes, or even lowering rates. The culmination of these factors, as well as the diversification, income, and choice benefits discussed above, point to a very positive outlook for fixed income across the board.
The bottom line
Again, the combination of higher rates and wider spreads means that valuations were restored in a very meaningful way, ultimately improving the forward-looking prospects for fixed income. As a result, investors have the opportunity to benefit from a better fixed-income starting point, with real rates positive across the curve. We haven’t seen this since the global financial crisis nearly 20 years ago, and it is all happening as inflation declines. The debate now is how fast and how far inflation can fall. But the key point is that the market now has some confidence that inflation is declining and will be contained. Given this environment, and the fact that this level of all-in yields hasn’t been seen for a decade, we believe investors should find fixed income to be very attractive.
Fixed income now offers investors more choice
Investors seeking enhanced income may also consider high-yield bonds. Since the start of 2022, high-yield bonds have more than doubled the income they pay and now compensate investors better against potential default risks (of the corporate issuers). Tighter credit conditions and a possible economic slowdown will not affect all companies equally, so it’s important to consider an active management approach to investing in high-yield bonds.
Considering an even longer timeline, Shiller data dating back to 1870 confirms that 2022 was the worst single calendar year for US Treasury (UST) total returns and the first year of back-to-back negative total returns (along with 2021). We believe a third consecutive year of negative UST returns is highly unlikely. The rationale here is that in 2022 there was an unforeseen worldwide inflation shock that combined with an aggressive and rapid response by central banks globally. A repeat of this scenario is not expected given the magnitude of rate hikes already executed and increasing evidence of moderating global growth and inflation. What’s more, we believe this backdrop should support stable-to-lower yields and healthier bond returns.
Fixed income offers compelling return potential
The classic potential diversification benefit of fixed income has returned, with the traditional 60/40 investment strategy working again. The evidence of this can be seen in the sharp decline of bond yields in March 2023 (notably at the front end of the yield curve) due to heightened concerns over US and European banking system stability. This is one indication that stock and bond market correlations are normalizing, and fixed income’s historical diversification benefits appear to be back. For a much broader perspective, consider the correlations of US Treasuries to equities going all the way back to 1926. The following chart illustrates just how much of an outlier year 2022 was with respect to the traditional correlations.
Fixed income offers potential diversification benefits
With valuations in better shape, inflation slowing, and volatility down, the case for fixed income today is very strong. Today’s higher yields have opened up potential opportunities for investors to generate better returns, diversify portfolios, and lock-in attractive income across the fixed-income spectrum.
Making the case for fixed Income
For investors who are positioning portfolios based on the long-term disinflationary trend, and assuming COVID was a historic one-off, the perennial question of “Where can I potentially find yield?” remains. As mentioned earlier, the one benefit emerging in the aftermath of this rough patch is that bond yields and valuations have been restored – so investors are now much more likely to find opportunities for lower-risk yield. Simply stated, valuations in the fixed-income market have not been this attractive in a very long time. Of course, that’s a reflection of the enormity and pervasiveness of last year’s bear market. Not only did Treasury rates move higher, but spreads also widened in non-Treasury sectors. The starting point matters, and that’s what fuels much of our optimism for the fixed-income asset class at this time. More attractive valuations against a backdrop of falling inflation set the table for an attractive investment environment.
The last year or so has undoubtedly been a daunting period to navigate. While most of 2022 was challenging, to say the least, for financial markets, given the negative returns for most asset classes, there has been some meaningful improvement and recovery over the last several months. Inflation pressures appear to be easing, and the Federal Reserve is likely near the end of its rate-hiking cycle.
Turning challenges into opportunities
LAST YEAR was spectacularly volatile for all asset classes, including fixed income. By some accounts, 2022 was one of the worst years for bonds since the Great Depression, as the economy attempted to emerge from the unprecedented global pandemic, heightened geopolitical tensions, and the fast emergence of record-breaking levels of inflation globally. As a result, the Federal Reserve (and global central banks more broadly) embarked on its most aggressive interest rate-hiking cycle in a generation, with a focus on addressing historically high inflation. The intention of most central banks across both developed and emerging markets was to raise rates to fight rising inflation, but ultimately those efforts squeezed liquidity, resulting in relentless pressure across all risk assets.
This rising-rate environment created a new problem by derailing the traditional inverse correlation of high-quality bonds and risk assets, particularly equities. Headlines decried the “death of the 60/40 portfolio,” (i.e., 60 percent stocks/40 percent bonds), which also had its worst year on record. However, while bear markets are brutal, they do provide a benefit: restoring valuations.
Published 12 June 2023
nominal annual return on us bonds
50
40
30
20
10
0
-10
-20
1872
1882
1892
1902
1912
1922
1932
1942
1952
1962
1972
1982
1992
2002
2012
2022
Percent
Source: Rober Shiller, Bloomberg. As of 31 Dec 22
Long US Treasuries and Equities – Yearly Total Returns Since 1926
Equities (%)
60
40
20
0
-20
-40
-60
-40
-20
0
20
40
60
2022
Source: Ibbotson, Bloomberg, Equities represented by the S&P 500. Long US Treasuries represented by Bloomberg Long US Treasury Bonds. As of Dec. 31, 2022
“Today’s higher yields have opened up potential opportunities for investors to generate better returns, diversify portfolios, and lock in attractive income across the fixed-income spectrum”
Mark Lindbloom,
portfolio manager, Western Asset Management Company
“The debate now is how fast and how far inflation can fall. But the key point is that the market now has some confidence that inflation is declining and will be contained”
Mark Lindbloom,
portfolio manager, Western Asset Management Company
News
Your Practice
Investments
Resources
Best in Wealth
Subscribe
Companies
About us
Privacy
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RSS
People
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Authors
Contact us
External contributors
Copyright © 1996-2023 KM Business Information Canada Ltd.
Long US Treasuries (%)