Strategic Income Outlook: Bobbing and Weaving
2022 has hit investors with an unprecedented 1-2 punch of sharply negative returns in both the equity and fixed income markets, but our Strategic Income team feels the selloff has created attractive opportunities in high yield bonds.
Bobbing and Weaving
Investors have never endured the 1-2 punch of negative returns in both equities and fixed income in the same year as they have so far in 2022. It has been 14 years since the stock market has fallen as much as it has this year (in 2008, the S&P 500 lost 37%). But unlike this year, Treasuries returned a tidy +20% in 2008, as the Fed was aggressively easing in response to the collapse in real estate and the mortgage-backed bond market that pushed many banks and financial institutions to the brink of insolvency. If you sold stocks and bought Treasuries early in 2008, you would have been fine, but not so in 2022. It has been very tough this year to find anywhere to hide outside of cash. Since 1988, there have not been any years where the decline in the 10-year Treasury bond return was greater than 10%, save 2022 year-to-date. We have to go all the way back to 1974 to find a year where the returns were somewhat analogous to what we have seen so far this year, but given the global nature of economies today, the speed with which information moves, and the role technology plays in linking global markets, it can be argued that going back that far for purposes of comparison may no longer be valid.
We know that each cycle is different and this one has unique characteristics. We are in uncharted territory as global central banks are collectively hiking rates to levels never seen before. According to Jim Reid of Deutsche Bank, over the last 24 years (which is as far back as we have reliable data), the ratio of global central bank rate hikes to cuts has never exceeded 5:1 until recently, when it reached 25:1! Clearly, looking in the rearview mirror gives us an excellent view of what has happened but it rarely, if ever, tells us what lies ahead. Our economic tour guide, Fed Chair Powell, seems to be in no hurry to give us a clue where we are headed, nor how long the ride will last. Sadly, everyone wants to know…and they want to know NOW! Markets generally hate uncertainty.
While the Fed has been telling us that they have the tools at their disposal to adequately quell inflation without causing a recession, most analysts and experts seem to believe that is not the case. Most suggest that the Fed will continue to hike until something breaks…likely the economy, and only then will they take their foot off the gas and stop hiking rates. That has been typical of the Fed’s track record in the past, and the way the market reacted in the month of September suggests to us that more investors are beginning to think that is the most likely outcome this time as well. From an investment standpoint, however, just because more people believe that a recession is coming is not necessarily a reason to sell everything and go to cash. One would only do that if the opportunity set of investments was not yet appropriately compensating an investor while pricing in the probability of a recession.