Bonds still have a place in portfolios—although possibly a smaller place—despite the challenges fixed income has faced for the first half of the year, according to Michael Arone, chief investment strategist for the U.S. SPDR Business at State Street Global Advisors.
“Bonds are still useful for capital preservation, income and diversification,” Arone said in an interview. “That being said, the environment remains challenging. Yields have come up some, but they still are at historical lows.”
Action taken by the Fed, resolution of the uncertainty of the mid-term elections, and a potential slowing of the war in Ukraine as winter sets in will be moderating factors for the volatility and economic problems that have been seen so far this year, the strategist said.
For now, State Street Global Advisors is leaning toward more conservative bond investments. There will be more opportunity to buy bonds in the coming months, but Arone said the firm wants to see credit spreads—the difference between the yield for U.S. Treasury bonds and other debt securities—increase from the current 5% to closer to 7% or 8% before making the move.
Investors may want to shift from a traditional 60/40 split to 70% equities and 30% bonds for now, he said. Investors who want to hold bonds should have their money in high-quality corporate bonds and short-duration bonds of three to five years maturity, rather than taking on more risk or committing to longer term durations, Arone added.
A number of factors have held bonds back so far for 2022. Higher interest rates, recession fears and persistent inflation have roiled bond markets so far this year, and headwinds are likely to intensify, not slow, for the remainder of the summer, putting even more pressure on fixed income markets, Matthew J. Bartolini, head of SPDR Americas Research for State Street Global Advisors, said in a report, “Bond Market Outlook: Balancing Risks for the Summer.”
“Fixed income investors may want to selectively allocate to active and indexed fixed-income strategies that seek to balance rate and credit risks,” Bartolini said in the report.
The market has not been kind to bonds so far this year. Core bonds have had their worst start to a year ever, falling 10% through the first six months of 2022 as a result of the rise in interest rates. On a rolling six-month basis, the return on bonds for the first six months of 2022 ranks as the third worst of all time dating back to 1975. The negative returns have not been confined to one specific market either, as all fixed-income markets were down, State Street Global Advisors said.
“The myriad macro risks moving markets this year have created an intensely challenging and complex environment for investors. Selective flexibility through tailored duration and credit allocations may help investors sail through the risks that continue to swirl this summer,” the report said.
However, there may be relief on the horizon for fixed-income investors.