In an outlook for 2024, the investment company PIMCO explains that there is a lot to be said for bonds in the current market environment.
• Growth and inflation have peaked
• PIMCO with strong bond outlook
• Stock investors are more optimistic about the market than bond investors
Strong outlook for bonds
As the Allianz subsidiary PIMCO notes in an outlook for 2024, bonds are rarely as attractive as they are currently compared to stocks. After turbulent years with significant inflation and rising interest rates negatively impacting portfolios, investors could potentially see a return to more conventional behavior in both equity and bond markets in 2024 – despite possible constraints on growth in various regions.
“In PIMCO’s latest ‘After Peak’ Economic Outlook, we shared our baseline assessment, which includes economic weakness in developed markets and, in certain regions, the potential for a downturn next year as fiscal support measures expire and the monetary policy (with the typical delay) takes effect. Our business cycle model indicates a 77 percent probability that the U.S. is currently in the late cycle phase and signals an approximately 50 percent probability that the U.S. will slip into recession within a year,” PIMCO said November 2023 Asset Allocation Outlook.
According to the forecast, growth has passed its peak, which also applies to inflation. If price levels move towards central banks’ targets by 2024, there could be a return to the usual inverse relationship between bonds and stocks, with bonds tending to perform better when stocks are struggling, and vice versa. Historically, in similar “post-peak” situations, U.S. Treasuries have delivered attractive risk-adjusted returns while equities have been more challenged, PIMCO continued.
Stock investors more optimistic than bond investors
As PIMCO also explains in the outlook, experts believe that stock investors would be more optimistic about the market than bond investors. To assess the implied probability of recession for various asset classes, PIMCO used indicators such as the equity risk premium (ERP), earnings per share (EPS), and credit default swap index (CDX) risk premiums. Their current levels were compared to those in a typical recessionary environment. “Currently, the S&P 500 (as measured by ERP and EPS) reflects a 14 percent probability of recession, well below the 42 percent implied by high yield bonds (as measured by CDX).” This optimism is also reinforced by the general profit and sales forecasts for S&P 500 companies. These would assume a recovery rather than a downturn. PIMCO is therefore concerned that the macroeconomic outlook could become decoupled from these earnings estimates and equity valuations, which would reinforce caution towards the asset class.
Expectation of interest rate cuts
As Institutional Money reports, citing Bloomberg, PIMCO also expects the Federal Reserve to start cutting interest rates in the middle of the year and eventually return to pre-2020 levels or slightly above them. This emerges from a paper available to Bloomberg. However, it is also emphasized that it is too early to declare victory over inflation. Inflation could rebound, driven by “recent market-based easing of financial conditions” combined with strength in the consumer and business sectors.
Bonds as a stable investment
“Given these risk scenarios, we believe it is advisable to hedge and keep multiple options open – especially since it is attractively cheap to manage volatility, particularly in equities,” explains PIMCO. “One strategy we favor is called ‘reverse seagull’ – where a put spread is funded by selling a call option.”
There is also a lot to be said for fixed-interest securities in multi-asset portfolios. Nevertheless, a wide range of investment opportunities are being targeted: “We are positioned for various macroeconomic and market-specific developments and value diversification, quality and flexibility.”
However, given the current initial returns, PIMCO favors fixed-interest securities – the comparison with equity valuations strengthens this preference. Bonds would offer the potential for attractive returns and could help stabilize portfolios during an economic downturn.
Editorial team finanzen.net
This text is for informational purposes only and does not constitute an investment recommendation. finanzen.net GmbH excludes any claims for recourse.
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