The US wealth management firm set out its thoughts on investment at its recent annual conference, and argued that certain types of bonds, for various reasons, are worth considering in portfolios.
Financial markets in the US appear to price in that high inflation has peaked and will fall back, while rattled bond investors should have opportunities to make money further out, according to figures speaking at the recent Baird Advisors’ annual conference.
Baird Advisors co-CIO Warren Pierson described what he called “pretty much the worst bond market ever” in 2022, as interest rates reset to much higher levels. Baird’s taxable and municipal funds experienced declines along with the rest of the fixed income markets, he said.
But Pierson said there is a silver lining to higher rates – the market finally has some room to run. Pierson described the era of “TINA” – short for “there is no alternative” – when bond yields were so low that many investors felt they had no choice but to invest in stocks, even at stretched valuations. That has given way to a market where investors can now “pay attention to the yield(s)” – “PATTY” for short.
The highest inflation for four decades, prompted by a mix of forces – quantitative easing over a decade, supply-chain disruptions, Green energy transition policies and Russia’s invasion of Ukraine – have prompted central banks to tighten monetary policy. The Federal Reserve raised the Fed Funds rate by 0.75 per cent at its July 2022 meeting and Fed watchers are widely expecting at least another 0.75 per cent hike later this month. The market is pricing in a Fed funds rate of more than 3.75 per cent by the end of the year.
Money supply growth is projected at 1 per cent by mid-2023, down from nearly 6.5 per cent at the beginning of the year, Baird Advisors said.
Bonds are looking attractive again
In its outline of the conference discussions, Baird said that with the benchmark 10-year Treasury yielding about 1.25 per cent a year ago, investors could be forgiven for concluding that “there is no alternative” to expensive equities. But with the 10-year now paying 3.2 per cent, and the opportunity to boost returns even further by selectively taking on credit risk, investors evaluating their options on a risk-adjusted basis should find it worthwhile to pay attention to yields and reconsider bonds.
The 1.4 per cent spread over comparable Treasuries paid by investment-grade corporate bond issuers is nearly half a per cent wider than a year ago. While that reflects investor concerns over the potential impact of a slowing economy on corporate borrowers, it isn’t an alarming increase that would indicate major problems in the credit markets, Baird said.
The US wealth management firm said municipal bonds also offer more opportunities. At the beginning of 2022, the average five-year “muni” was yielding less than half as much as a five-year Treasury bond, but by September the yield had climbed to nearly 70 per cent that of a comparable Treasury.
“As interest rates normalize after spending the better part of the last decade near zero, compelling opportunities are beginning to emerge in fixed income markets. With the economy resetting from a global pandemic and the Fed wrapping up its pitch battle with inflation (while simultaneously unwinding its own massive balance sheet), there will no doubt be additional volatility along the way,” the firm said.