Bond investors have had a rough few years since the start of the COVID-19 pandemic, but the tables look like they’re about to turn.
That’s according to fixed-income giant Pimco, which oversees $2.3 trillion in assets.
Since early 2020, 10-year Treasury yields have risen from 0.65% to 4.8%. An inflation flare-up in 2021 and 2022 fueled much of that rise, and yields have again surged in recent months as investors worry about rising oil prices and government debt levels. When bond yields rise, bond values decrease.
But long-dated bonds have slid far enough now that the assets look attractive specifically for their yields, Pimco multi-asset credit strategist Lotfi Karoui wrote in a note on Tuesday. That’s because current yields offer attractive income levels to offset portfolio losses, as well as a high enough starting point that they can appreciate in a poor growth environment, he said.
Investors can expect the broader bond market to deliver anywhere from 4% to 6% annualized returns in price appreciation over the next five years, Pimco data shows.
“In today’s investing regime, we see a strong case for boosting bond allocations and restoring more balance to portfolios that are heavily exposed to equity markets — and equity risks,” Karoui wrote.
Karoui pointed out that one-year forward S&P 500 earnings yields are hovering around the same level as yields on the Bloomberg US Aggregate Bond Index, and have been for the last few years.
PIMCO
Generally, investors are compensated more for owning stocks, which are higher risk than much of the fixed-income universe, but the paradigm has shifted, and the return profile of bonds is looking nearly as good, especially given the lower risk.
“Bond yields have reset to higher levels, offering more visible return potential, while the premium for taking incremental equity risk now looks unusually thin.”
In light of the recent bond sell-off, along with historically high valuations in the stock market that threaten to dampen long-term returns, bonds are again a compelling buy, Karoui said.
Yet many investors are still underweight bonds, as it’s been a drag on portfolio values over recent years.
“For much of the past 16 years, investors who chose bonds over stocks felt punished, especially given the cumulative returns in the buoyant stock market,” Karoui said.
“Many investors who endured those losses years ago haven’t returned to bonds,” he continued. “That experience still shapes the relative allocation of multi-asset portfolios today.”
Case in point, US households have around 32% of their assets in stocks, a record high, he said. Meanwhile, just 4% of their portfolios are in fixed income.
If that resembles your portfolio, Pimco has a message for you: bonds are back, and are no longer the portfolio dead weight they’ve been over the last decade and a half.