Even if you see yourself as a clearheaded investor with an open mind on events, it can be hard to resist the pull of market narratives.
Rewind to the outlooks penned at the end of 2022. After a dismal year for equities and bonds, attention was turning to the point at which interest rates and inflation might soon peak. While few money managers held much hope for shares, many saw a clear reason for investors to pile into fixed income.
The thinking went that, amid the rubble of an economic and earnings recession, so would emerge a path to lower borrowing costs and lower inflation, and therefore a big swing back to bonds among investors.
For Morgan Stanley, 2023 was set to be a “much stronger year” for the asset class, which the bank expected to “generate decent positive returns”. Schroders called the backdrop for bonds “compelling”, while BlackRock urged investors to consider stepping out of cash and into “high-quality, medium-term fixed income”.
The Investors’ Chronicle wasn’t immune to the view. While warning of the risk stagflation could still pose, we suggested that yields on some bonds were starting to look enticing. This writer, for one, even suggested “the stars may just have aligned for fixed income in 2023”.
What, then, has happened since? The MSCI World equity index, powered by a huge run from US shares, has posted an 18 per cent total return in dollar terms (or 11 per cent in sterling) so far this year. By contrast, iShares’ Core Global Aggregate Bond ETF is up around 2 per cent which, with inflation still high, equates to a real-terms loss.
A seemingly nailed-on trend hasn’t played out as thought. Although countless obituaries for the 60/40 portfolio were written at the end of 2022 and in the months before, sticking to the classic stock-bond allocation model would have returned 11 per cent so far in 2023 in dollar terms, above the 10-year annualised rate of 8 per cent.
Put simply, the herd view that a bond pivot was imminent has been premature. Interest rates in many economies are still going up, and while there are signs that global price rises are now peaking, few believe that the final yards of the inflation battle will be easy.
Last week’s decision by the Bank of Japan to loosen controls on its bond yields signalled that its ultra-loose monetary policy and massive liquidity injections are ending, sparking a sell-off in other sovereign bonds. Markets might either be on the bumpy road toward a new normal, or in a new normal that is simply bumpier than what came before. Nascent fears that the global economy may already be growing too fast only add to the whipsaw effect.
As such, it might still be too soon to turn to the big market call for 2023. A recent survey by the French bank Natixis found 72 per cent of investment managers feared lingering inflation could hurt fixed income in the second half of the year. Even if equity prices fade in the coming months, bonds will have to rally hard to catch up, while inflation will need to fall heavily for bonds’ real returns to turn positive.
This may still happen. State Street recently reiterated its view that “this is the year of fixed income”. Without explicitly making the case for bonds, Oxford Economics thinks the equity rally has “been too far, too fast”, and that stocks’ relative valuation to fixed income now points to a looming equity sell-off. In its mid-year outlook, JPMorgan advised its wealth management clients to start switching from cash to bonds, noting the latter’s two-year outperformance following each of the last seven peaks in the Fed’s rate hiking cycle.
After the latest 25 basis point hike to 5.5 per cent, markets believe that peak has arrived, at least in the US. Quite how smooth the descent will prove remains anyone’s guess.
Asked whether this year had demonstrated the fallacy of trying to time asset class tilts, State Street Global Markets’ head of macro strategy Michael Metcalfe dodged the question, instead pointing to the divergence between different asset returns as evidence for the “potential opportunities available for investors if tactical asset allocation decisions are timed correctly.”
We know from both history and academia that timing has a huge impact on returns. We also know that it is impossible to consistently get right.
At a media roundtable event last month, Metcalfe made light of a presentation screen behind him, which suggested the event was being held in July 2022. “I wonder, if we had perfect foresight of how the macro picture would unfold over the past year, whether we would have called markets correctly,” he said.
It’s a sound observation. Markets aren’t the same thing as macroeconomics. While bonds offer the chance to lock in yields and reduce risk, they only make sense when their returns beat inflation. Equities, while always appearing to suffer from what Alan Greenspan called irrational exuberance, have a habit of proving they should never be written off.
