The past year will have left a bitter taste in investors’ mouths, with portfolios down 14.40%, on average, for a balanced profile in euro (1). But it was the 18% (2) decline in bonds that really left its mark, with the spectre of inflation returning to haunt the markets, since inflation is the bond markets’ worst enemy. Add to this the rise in key rates and, after years of historically low interest rates and coupons, all the elements combined to deliver the worst year for the asset class in a long time.
2023: the year of the bond market revival
The brutality of the unique inflationary supply shock that we experienced last year prompted central banks to drastically alter their monetary policies. While the process of disinflation seems to be under way in the United States, economic activity is also beginning to show signs of slowing down. Despite this, we expect the hawks will remain in the driving seat at the next few Federal Open Market Committee (FOMC) meetings.
Sooner or later, however, monetary policy will change to the benefit of bond investors. Bonds’ risk/return ratio is already looking attractive. The stars therefore seem to have aligned to make 2023 the year of revival for bonds.
Like equities, bond markets have made a strong start to the year. Despite the recent rebound, which saw the yield on US 1-10 year corporate bonds fall from 5.33% to 4.80% (and the 10y US Treasury from 3.87% to 3.40%), the markets still seem attractive enough to support a barbell positioning, including short-term investment grade corporate debt and a long positioning on sovereign debt, in anticipation of an economic slowdown and a rise in the credit risk premium. As an example, the following yields are obtained on 1-3 yr Corporate Investment Grade in francs, euros and dollars respectively: 1.40%, 3.73% and 4.87% (3). Such yields have not been seen since 2008. It should also be noted that after eight years, negative-yielding debt has disappeared (except for short Japanese sovereign debt).
After years of disappointing returns, will the traditional 60/40 portfolio (which on average posted a yield of 8.8% in dollars from 1926 to 2021) make a comeback? This will depend on the direction of inflation over the coming quarters. Let’s just say that a multi-asset portfolio now makes sense again, and one of the priorities of the typical investor will be to (re)build a balanced and resilient portfolio while generating income and staying diversified. As for “TINA” (There Is No Alternative), it will no longer be invited to the great investment ball.