On Market Uncertainties, Bond Opportunities and the 60/40 Portfolio
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Nieves: Good morning, and good afternoon, everyone. My name is Roger Nieves. I’m joined here today by Dan Ivascyn, so it’s been quite a choppy start to the year here in 2022.
Text on screen: Roger Nieves, Senior Advisor, U.S. GWM Advisor Education
FULL PAGE GRAPHIC: TITLE – Market volatility has spiked. Subtitle: VIX Index with historical average. The chart plots the VIX index from 1990 through June 1, 2022 and shows several periods of elevated volatility (blue line), which was highest during the 2008-2009 financial crisis and at the start of the coronavirus pandemic in 2020. The red line represents the VIX Index’s historical average. Volatility increased at the beginning of 2022, although at a much lower level compared to the 2008 and 2020 spikes, and has somewhat leveled off.
What should financial advisors be telling their clients about the outlook for the economy right now?
Ivascyn: Sure. Well, you’re absolutely right, it’s been a choppy market environment and an environment with a tremendous amount of macro uncertainty. Various cross-currents.
Images on screen: COVID re-opening and shipping
Covid reopening, which is a positive scenario for the economy, but it’s leading to some pressure on prices given existing supply bottlenecks.
Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
And although we anticipated a lot of volatility this year, didn’t anticipate war on the ground in Europe, which is quite significant, of course, both in terms of more base case scenarios but also the type of more extreme uncertainty that that now creates across the global economy, particularly in Europe.
But with bombs falling and risks around NATO engagement and expansion of the conflict, it’s really, really challenging for investors who of course are dealing with a high inflationary environment as well.
So I think the bottom line from an investment perspective is to have a healthy degree of humility, realize there’s going to be a lot of volatility, a lot of uncertainty, and just be careful in sizing positions, be careful about being too overconfident regarding markets.
Any time you have this uncertainty and central banks tightening policies as opposed to loosening policy, you can have significant overshooting, and that can be a great opportunity for the patient investor, but it can be a quite troubling time if you are overconfident, if you’re taking excess risk relative to your own personal financial goals.
This is an environment that can create some damage. So bottom line, we expect more uncertainty, more volatility. That’s great from an active asset management perspective, but you also need to respect the fact that things could get a lot worse before they get better, both on the inflation front and then even some concerns around economic growth.
FULL PAGE GRAPHIC: TITLE – Starting yields across asset classes. Subtitle: Today yields are at a much stronger starting point. The bar chart shows yield to worst (YTW) for various fixed income sectors during two starting periods – December 31, 2021 and April 30, 2022, with YTW for all sectors higher during April 2022 compared to December 2021. YTW is a measure of the lowest possible yield that can be received on a bond. Shown from the left are Core Bonds, Agency Mortgage Backed Securities (MBS), Investment-Grade (IG) Credit, High Yield (HY) Credit, Emerging Markets (EM), Municipal Bonds, and High Yield Municipal bonds. Also shown is the year-to-date change in yields, as measured in basis points (bps), with Core Bond yields up 177 bps, Agency MBS up 181 bps, IG Credit up 192 bps, HY Credit up 268 bps, EM up 194 bps, Munis up 353 bps, and HY Munis up 334 bps.
But valuations are looking more interesting, and finally, we have some yield and some spread to get a little bit excited about.
But it will be a choppy market environment certainly going into year end.
Nieves: So yields are better, as you were saying, and hopefully bonds are still in a really good position to provide that capital preservation in investor portfolios. And then the
FULL PAGE GRAPHIC: TITLE – Investors reacting to markets: money in motion. The pie chart depicts the share of various asset classes, with stocks taking the biggest share, followed by non-U.S., bonds, cash and alternatives.
benefit that we often speak to Financial Advisors about is diversification to equities, right. which struggled a little bit earlier in the year but more recently, we’ve started to see a little bit of that diversification come back into the bond market.
Do you think that bonds are still well positioned to be that diversifying force in the 60-40 portfolio?
We know a lot of advisors have been receiving emails that say the 60-40 portfolio is dead, but that may not necessarily be the case.
Ivascyn: Yeah, so we don't believe 60-40 is dead. But your specific question of the role of fixed income as a diversifier over the next few months is a tough one to answer. There’s a lot of uncertainty there. But you’re absolutely right,
FULL PAGE GRAPHIC: TITLE – Two-year and five-year yields have increased. The line chart plots the 2-year U.S. Treasury yield (blue line), the 5-year U.S. Treasury yield (green line) and the federal funds rate (upper bound, red line) from March 2015 through March 2022. The 2-year and 5-year yields rose significantly from their lowest levels in March 2020. As of March 31, 2022, the two-year and five-year yields were close to reaching their highest levels since around September 2018.
it appears that rates have gone up fast enough and to a level now where you’re beginning to see people becoming more concerned about a recession, more concerned about equity valuations, equity earnings, so you have seen the scenario when stocks have gone down, bond prices have gone higher.
So we do expect to get back to that more traditional relationship soon. And I’ll define soon as over the next year or so. It can happen sooner than that, because there is this great struggle between the real economy and the financial economy.
And we’ve seen prior economic slowdowns be driven by weakness in risk assets, and we very well could see further weakness that leads to further tightening of financial conditions to slow the economy on its own.
But now that inflationary risks are the primary risks people are focusing on, and you get more concerning high inflationary prints, you could quickly swing back to that bad correlation environment that we’ve been in for much of the last few quarters, where stocks sell off, bonds sell off, and that’s where, again, the traditional 60-40 doesn’t of course work well under that scenario.
So this is, again, a journey towards a time when inflation gets back within reasonably acceptable ranges for central banks. We as a firm are fairly confident that over the course of the next year or two, we do get inflation back to more reasonable levels. And when that occurs, when other participants believe that trend is beginning to form, then I do think you’ll begin to see that more traditional correlation return where down equity days likely coincide with up bond prices or at least at a probability closer to what it was just a few years ago. But a lot of uncertainty over the short term.
Nieves: Dan, thank you very much for your time today, and thank you to all of you for joining us for our discussion.
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