Text on screen: PIMCO
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Text on screen: Ken Chambers, Fixed Income Strategist
Ken: Let's talk about the yield environment. Government bonds as well as spread asset classes continue to have elevated levels of yield. At the same time, we have Fed officials talking about a higher rate environment for longer. What does that mean for the bond market as we move forward?
Text on screen: Marc P. Seidner, CIO Non-traditional Strategies
Marc Seidner: Ken, it really depends on your time horizon, first and foremost. I mean, the good news is fixed income investors, and I don't want to overplay this,
FULL PAGE GRAPHIC – Today’s yields are at a much higher starting point
The bar chart shows yield to worst maturity (YTM) for various fixed income asset classes have moved significantly higher as of September 30, 2023 from December 31, 2021 levels. Fixed income asset classes included in the chart are U.S. Core with 5.4% YTM as of September, Global Aggregate with 5.6%, Agency Mortgage Backed Securities with 5.5%, AAA Securitized Bonds with 6.3%, Municipal Bonds with 7.3%, Investment Grade Credit with 5.9%, High Yield Credit with 8.2%, and Emerging Market Bonds with 7.1%.
but your starting point of yield is highly predictive of your future return.
So in some regards, while the economic environment is increasingly uncertain, and while there are elements across a wide range of possible outcomes that are currently embedded in economic outlooks, the starting point of yields make it easier if you've got a long enough time horizon.
And to take that point even further, there's something for almost everyone to do in the bond market today, right now. Whether you have a risky portfolio and you're trying to hedge against possible left tail or negative economic scenarios,
FULL PAGE GRAPHIC - Investing today: Pivoting to fixed income
The chart shows three characteristics of fixed income, namely Predictability, Resiliency, and Flexibility.
the starting point of a 4.6%, 10-year treasury note potentially gives you a lot of downside protection if economies turn into a more negative scenario, like we expect, or even a more nefarious type of scenario. If you're looking for a starting point of attractive yield, core and intermediate fixed income is there. I mean, you're offering 6%, 6.5% type of income levels, which is historically quite attractive.
If you are not certain about the level of yields and think rates could continue to go higher for a period longer, short and intermediate maturity bonds offer very attractive ways of locking in current levels of cash rates for at least the next two or three years. The problem with cash right now is it could go away real quick. A 5.25%, sort of, deposit rate or short-term interest rate looks really good right now, but a year from now, that could be substantially lower than it is. That's one possible scenario. If you're worried about a more sticky inflation scenario, the real yield on a 10-year inflation protected bond gives you a starting point of 2.3% plus inflation. And the breakeven inflation rate's only expected to be 2.25% or 2.33%.
I mean, I don't want to sound like a bond manager who likes bonds too much but I will sound like a bond manager who likes bonds quite a bit.
FULL PAGE GRAPHIC: U.S. equities: Expensive relative to bonds versus last decade
The line chart shows estimates for U.S. equities’ earnings yield in the next 12 months, as measured by the S&P 500 Forward Earnings yield (green line), which fell from approximately 7.8% in 2013 to approximately 5.8% as of September 30, 2023, while BBB Credit Yield, as measured by the yield to worst maturity for the Bloomberg U.S. Aggregate: Baa Index (blue line) rose from approximately 4.8% in 2013 to approximately 6.2% on Sept. 30, 2023. The Spread (red line) fell from approximately 5% in 2013 to approximately -1.0% on September 30, 2023.
When we look at the opportunity set across the asset allocation environment, we do think bonds offer much more attractive potential returns than investment opportunities further down the capital structure, including equities. From a simple valuation perspective, the earnings yield on the S&P 500 is now lower than the all-in yield of the triple-B rated corporate index. When you can move up in quality, move up the economic capital structure and have a potentially higher return, that does guide us to liking the fixed income opportunity set more than opportunities in equities right now.
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