Looking for deals in the middle of the sale? Consider Bonds

Bonds haven’t garnered as much attention from investors as distressed tech stocks and bitcoin during this year’s bout of financial market volatility, but some observers are now considering opportunities in the battered asset class.

The main reason: Bond yields have risen to levels where they are now challenging dividend-paying stocks, providing investors with a level of income that hasn’t existed for years, at a time when economic clouds are moving.

To be sure, bond yields rose because bond prices – which are moving in the opposite direction to yields – have fallen.

The yield on the 10-year US Treasury, which offers a good snapshot of the entire bond market, rose from about 1.5 per cent at the end of 2021 to a high of about 3.5 per cent earlier this week.

That represents the highest Treasury yield since 2011. It’s well above the 1.6 percent dividend yield for the S&P 500.

The sharp increase in bond yields, which ended a 40-year bond bull market, came amid a surge in inflation to its highest levels in decades and an increasingly violent response from major central banks.

The Federal Reserve this week raised its key interest rate by three-quarters of a percentage point – the largest single increase since 1994. Economists expect more increases this year, not only from the Fed, but also from the Bank of Canada and others.

The Bloomberg US aggregate bond index, which tracks a group of US government bonds, corporate bonds and mortgage-backed securities, is down 12 percent this year, its worst performance since 1976.

The problems are not limited to the US market. The iShares Core Canadian Universe Bond Index ETF, an exchange-traded fund that trades on the Toronto Stock Exchange that tracks Canadian bonds, is down more than 14 percent this year.

No one knows if the sale is over or not, yet there are compelling reasons to take a closer look at the bonds.

“There is a critical pivot that needs to happen for fixed income to become interesting again,” David Klitz, portfolio manager at Forstrong Global Asset Management, said in an interview.

He said the pivot could come as investors shift their attention from their current focus on inflation to what comes next. Higher interest rates should slow economic activity and cool inflation.

“When the focus begins to shift to economic growth, it can actually help lower bond yields,” said Mr. Kletz.

As bond yields fall, bond prices rise — and it’s no surprise to bet that this will happen. Inflation and hikes in central bank interest rates appear to have been priced largely in bonds already. but dangerous A slowdown in economic activity, if not a complete recession, is not.

Economic slowdown “will drive inflation lower, which is what all this tightening was all about. Mission done. Now, to help everyone get back on their feet, you’ll start,” Jennifer Lee, BMO Nesbitt Burns economist, said in an email. price cuts.”

The 10-year US Treasury yield ended the week a little off its previous highs, at 3.24 percent — suggesting, perhaps, that the pivot in this bleaker economic outlook has begun.

Some investors are already moving on to this opportunity here.

Michael Kontopoulos, director of fixed income at Richard Bernstein Advisors in New York, published a note this week saying that financial markets tend to under- and over- target, and the bond market today is no different.

Case in point: Investors have significantly overvalued Treasuries over the past year and a half, resulting in returns that have been very low. However, today investors have come close to fair value, and by some measures, Treasuries are undervalued. Compared to our estimates,” Mr. Kontopoulos wrote.

He believes that if there is a recession over the next two years and the yield on the 10-year US Treasury falls to 1.5 percent, anyone buying bonds today will see an investment gain of 17 to 23 percent.

“It is clear that the upside/downside trend has shifted, creating an opportunity for us not seen in a long time,” said Mr. Kontopoulos.

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