What a Rough Quarter for Bonds Means for Asset Allocators
Sébastien Page, Head of Global Multi-Asset and Chief Investment Officer
Tim Murray, Capital Markets Strategist, Multi-Asset Division
The bond market just had its worst quarter in more than 30 years. In fact, U.S. Treasuries performed worse than they have in a three-month period dating all the way back to before the Great Depression. So Sebastien, What happened?
Well let’s put the last few months into context. The Bloomberg Global Aggregate Index turned 32 years old in January, and in that history Tim:
- March was the single worst month ever (-2.16%), down more than 2% in one month, which was unusual for bonds
- Q1 2022 was the worst calendar quarter ever (-4.97%), down almost 5%.
Look, lower bond returns are not wholly unexpected when the Fed turns more hawkish. In the first quarter, we saw expectations for rate hikes basically for the Fed more than double.
And what I see as even more unusual is that, in a quarter in which stocks were largely down, bonds were also down. So stocks and bonds typically move in the opposite direction during market sell-offs. So what happened?
That’s unusual too, but it is not unheard of. Rising rates and inflation shocks can be bad for both stocks and bonds at the same time. We’ve already talked about the Fed. In addition, Russia’s invasion of Ukraine added an inflation shock on top of the COVID supply chain inflation shock. Tim, this is a shock on top of a shock.
That’s why we’re seeing a sustained positive correlation between stocks and bonds returns basically for the first time in 10 years.
And of course, diversification underpins well-built portfolios, and, Sébastien, you’ve written quite a bit about the power of diversification. But the question asset allocators may be asking now is—and I’m gonna be a bit dramatic on purpose here—Why invest in bonds at all?
Yeah Tim, that's a dramatic question. I think getting out of bonds completely would be short-sighted for most investors. We think a lot of the Fed’s hawkish turn has been priced in first of all. Besides, if we get a large equity sell-off, Treasuries could still be the most defensive asset class in a portfolio. It's very hard to find alternatives to Treasuries. And remember, when rates rise, the expected return on bonds rises too, which could provide a better entry point. Bonds are cheaper now than they were a year ago.
Alright, let’s talk about Asset Allocation Committee positioning. The Fed made it pretty clear at the end of last year that it was moving toward a more hawkish stance. And we adjusted. Coming into the year, our Asset Allocation Committee had lowered our exposure to interest rates while also favoring higher-yielding sectors such as floating rate. So, how are we positioning now?
That’s right, Tim. We were positioned for the Fed to adjust from a tactical perspective. Also, we maintain a strategic or long-term allocation to investment-grade bonds, we also include alternatives such as absolute return-oriented strategies. Tactically, if we take a six-to 18-month horizon, we are also overweight to higher-yielding sectors, including in particular floating rate loans, and, for potential defense, short-term TIPS.
- In the first quarter of 2022, the bond market had its worst three-month performance in more than 30 years.
- Although bonds usually have an inverse relationship to stocks, rising interest rates and inflation shocks are typically headwinds for both asset classes.
- Our Asset Allocation Committee is slightly overweight to bonds, favoring higher-yielding sectors including bank loans, high yield bonds, and short-term TIPS.
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