If returns on global equities flatten out over the next 12 months, investors shouldn’t look to the bond universe to juice their portfolio returns because, according to asset managers and allocators, that’s simply not what fixed income is designed to do.
As the bull market in equities reaches its 11th anniversary, a vocal and growing minority of market commentators are warning that returns on traditional asset classes may be flat, if not negative, in the years to come. Should equity markets lose their strength, investors aren’t likely to find solace in bonds.
And that's because economic growth – and interest rates with it – are expected to remain low over the next year, said Gautam Khanna, senior portfolio manager at BNY Mellon’s Insight Investment.
“There are a lot of concerns from a global perspective in terms of growth rate,” said Khanna. “There are concerns about disinflation, whether it’s related to demographics or the amount of debt outstanding in the system, all of that suggests that maybe the Fed is going to remain on the sidelines for a period of time. It may be a quarter or two before we get enough new data to justify a shift from their current policy stance.”
Since fixed income returns are strongly linked to interest rates, lower-for-longer global monetary policy means that returns are also likely to be lower for longer.
It’s not that growth will be negative, said Jon Adams, senior investment strategist at BMO Global Asset Management. But with trade concerns easing and investor worries over geopolitical conflict in the Middle East dissipating, some moderate growth is possible simply because the outlook on U.S. and global policy has improved.
“We’ve had a flurry of positive policy surprises to close out 2019,” said Adams. “Thus, our policy outlook has turned more supportive, and that’s a positive for risk assets in general. It gives us more conviction in our overweight equity view.”
Adams said that many of the problems that market bears point to, like student loan debt, growing concern over subprime auto loans and a slowdown in commercial real estate, are not in areas of the market significant enough to cause recession.
Jeffrey Elswick, director of fixed income at Frost Investment Advisors, agrees that recession is not likely in the near future but warns that the global economy is likely to encounter challenges in the year ahead.
“We started saying this to clients quite a few years ago, but we feel like this macro cycle has several more years to go – at least, that’s the scenario with the highest probability,” said Elswick. “The probability of recession goes up every single year, we’re 11 years into this bull market, and we also have some near-term challenges.”
Challenges might be a good thing for fixed -ncome investors. Bonds often display a tendency to move in opposite directions from equities, so while a major geopolitical shock like the U.S.’s rocket attack that killed Iranian general Qasem Soleimani on Jan. 3 sent equity markets tumbling, it had an inverse effect on the Bloomberg Barclays Aggregate Bond Index, sending the largest index of investment-grade bonds higher.
Such events are difficult, if not impossible, to predict, but there seems to be some consensus around a GDP growth rate near 2% for 2020, just barely beating inflation. Elswick said that muted economic growth probably means 2% to 2.5% returns from fixed-income investing, but more positive economic news could cause the bond universe to go negative.