Bonds could beat stocks in the coming months, potentially breaking their similar performance trajectory in 2022 as recession fears weigh on markets, according to a note from Capital Economics.
“After moving broadly in the same direction for much of 2022, we believe returns on ‘safe’ assets will generally diverge from those on ‘risky’ assets by the middle of next year,” John said. Higgins, Head of Markets. economist at Capital Economics, in a note Tuesday. “We suspect that long-term government bond yields have peaked in most places and will continue to fall as inflation wanes and the global economy slips into recession.”
Traditional investment portfolios of 60% stocks and 40% bonds have taken a beating this year as the Federal Reserve hikes interest rates in a bid to cool the economy and tame the high inflation. According to Higgins, “simultaneous declines in bond yields and stock prices would be consistent with the experience of some of the recent Fed tightening cycles that were followed by US recessions.”
NOTE ON CAPITAL ECONOMICS ASSET DISTRIBUTION DATED NOV. 1, 2022
Investors are waiting for the outcome of the Fed’s two-day policy meeting, which ends on Wednesday, for clues about its future rate hike path.
The U.S. stock market opened higher on Tuesday amid a sharp drop in Treasury yields, but gains in equities were erased later in the morning after a report from the Labor Department showed that bids for Employment jumped in September despite the Fed’s efforts to cool the economy through tighter monetary policy. .
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Meanwhile, 10-year Treasury yields reversed most of their sharp decline seen around the U.S. stock market open on Tuesday, FactSet data showed, at last check. The yield of the 10-year Treasury note TMUBMUSD10Y,
was down just 2 basis points to around 4.06% in Tuesday afternoon trading. Yields and bond prices move in opposite directions.
In other economic data released on Tuesday, a report from the Institute for Supply Management showed its closely watched index of U.S. manufacturing activity fell in October to 50.2% from 50.9% in September. This is the lowest level since May 2020, with prints below 50% reflecting a shrinking economy.
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The further decline in the ISM manufacturing index “illustrates that the weakness in the global economy and the past rise in the dollar are catching up with the manufacturing sector,” Andrew Hunter, senior U.S. economist at Capital Economics, said in a separate note on Tuesday. “But the biggest news is that, partly because of this slowdown in demand, pricing pressures in the goods sector have evaporated.”
Capital Economics expects stocks to bottom later than bonds, according to Higgins’ note.
Most risky assets could continue to struggle “despite lower ‘risk-free’ interest rates” after a spike in long-term government bond yields, he wrote. “While we think long-term bond yields have now peaked in most places, we still see more pain for many risky assets by the middle of next year, as a recession world takes hold.”
According to Higgins, both safe and risky assets have recently posted losses as central banks raised rates to combat high inflation.
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“We suspect the Fed may want to see more evidence of easing inflationary pressures before giving further encouragement to hopes of a monetary policy ‘pivot’,” he wrote. “Even so, we also believe that long-term Treasury yields have now peaked and will fall significantly next year, as a decline in inflation will ultimately help end the Fed’s tightening cycle and put rate cuts on the agenda.”
While falling bond yields will ease pressure on equity valuations, the decline “will also initially be accompanied by rising risk premia and disappointing corporate earnings growth as much of the economy world, including the United States, is in recession,” Higgins warned. .
“Longer term, we believe most risky assets will fare better in the latter part of 2023 and 2024,” he wrote, “as the global economy turns a corner and a Continued fall in inflation leads to further declines in government bond yields.”
Meanwhile, the iShares 10-20 Year Treasury Bond ETF TLH,
lost about 28.6% this year on a total return basis through October, according to FactSet data. The iShares 20+ Year Treasury Bond ETF TLT,
suffered a larger loss of 34.1% over the same period.
All three major U.S. stock indexes were down on Tuesday afternoon, with the Dow Jones Industrial Average DJIA,
falling 0.3%, the S&P 500 SPX,
down 0.4% and the technology-heavy Nasdaq Composite COMP,
down 0.7%, according to FactSet data, when last checked. That left the S&P 500 down about 19% so far this year.
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