By some distance, it’s been the most brutal year ever for aggregate bond indices and exchange-traded funds (ETFs) – many of which have only been around for a couple of decades or less. But you have to go back centuries in some cases to get anything nearly as bad as 2022 for ‘safer’ sovereign bonds.
While short-dated U.S. Treasury losses were limited to less than 10%, the 23% drop in annual returns of the 10-year U.S. Treasuries through last month was – according to Bank of America – the worst since the turbulent infancy of the republic in 1788.
What’s more, it looks set to be the first back-to-back year for Treasury losses since 1959.
Surely there won’t be a third?
Not according to asset managers now setting out their stalls for 2023 – many of whom have already spied 10- and 30-year Treasury yields over 4% last month as a good place to lock in.
If their dominant year-ahead themes of disinflation, recession, peaking central bank rates and a cresting dollar play out, a return to bonds and revenge for the 60/40 portfolio model – which also had its worst year in a century – is at hand.
“2023 will be the year of the bond,” claimed Chris Iggo, chair of the AXA IM Investment Institute.
“Bonds are back,” reckons Amundi Chief Investment Officer Vincent Mortier.
Societe Generale’s global asset allocation team, which already upped the share of bonds in multi-asset portfolios as early as September, said another upgrade was warranted going into next year and added higher quality credit and investment grade bonds.
“Road to recession – bullish bonds and quality credit,” was how SocGen entitled their view.
‘PULL TO PAR’
Positioning-wise, the increasingly bullish asset management consensus seems at odds with high-octane money that remains negative on fixed income for the most part.
Speculative hedge funds are still heavily net short of 2- and 10-year Treasury futures, according to the latest data from the U.S. Commodity Futures Trading Commission, with net shorts on the 2-year now the biggest on record.
So it’s far from a crowded trade yet.
Global investors polled by BofA earlier this month still reported being some 20% underweight in bonds on aggregate.
But with recession and falling inflation now a majority expectation, the BofA survey showed funds close to a tipping point. The percentage of those expecting lower long-term yields over the next year exceeded those expecting them to rise for the first time in the survey’s history.
And while economic downturn and disinflation are good for bonds now with the highest yields in decades, they are much less so for equities now wary of outsized earnings hits – leaving the 2023 outlook for stocks far murkier and potentially volatile.
Indeed, neither Goldman Sachs nor Morgan Stanley sees an end to the bear market in equities and both see Wall Street stocks ending next year pretty much where they are now.
And while stock volatility makes forecasters nervy, there’s a clear attraction for long-term funds in seeking both the fixed income as well as the lift to bond funds when sub-par price discounts disappear into maturity for most high-quality names.
Iggo at AXA insisted the “risk-return trade-off is much better for bonds.”
“At the index level, yields are higher per unit of duration and credit risk than they have been for years,” he said. “Higher yields mean lower bond prices, and even if yields don’t fall, bondholders will benefit from a strong ‘pull-to-par’ as prices converge on 100 over the remainder of their maturity.”
And if you want an accelerator for that play, U.S. investors could get a significant tailwind in overseas bonds from a likely retreat of the dollar.
“Long high quality bonds in the U.S. and Europe seems like an obvious strategy for 2023,” said hedge fund manager Stephen Jen at Eurizon SLJ Capital.
“The dollar has peaked and could weaken steadily for the next year or so,” he said, adding a near 20% “overshoot” against major currencies was as big as it was just before 1985’s G7 Plaza Accord or on the eve of the 2000 dot-com bust.
The opinions expressed here are those of the author, a columnist for Reuters.
Bond indices and fundshttps://tmsnrt.rs/3U376Ty
2022 Asset Performancehttps://tmsnrt.rs/3Va2FaL
Ten-year yield cresting?https://tmsnrt.rs/3VatZWn
BofA chart on historic Treasury losseshttps://tmsnrt.rs/3EV1nK3
(by Mike Dolan, Twitter: @reutersMikeD; Editing by Paul Simao)
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.