Three Narratives Overshadow Fixed-Income Investing In 2020

After most investors in passive, balanced portfolios ended 2019 with significant returns in both their equity and fixed-income allocations, they may be due for a return to more normal return patterns in 2020.

After all, it’s unusual for both equities and bonds to increase in value simultaneously--but that’s what happened in 2019, as the S&P 500 offered investors total annual returns of more than 30%, while the Bloomberg Barclays Aggregate Bond Index rose by more than 8.7% in the same year.

But 2020 will probably be trickier, said Jeffery Elswick, director of fixed income at Frost Investment Advisors.

“Our base forecast for 2020 is looking like a year of around 2% returns,” said Elswick. “Maybe 2.5%, give or take, but much lower than the returns of 2019. In 2019, everything in the U.S. bond market has essentially produced positive returns except one area--high-yield credit in cyclical industries. Pretty much everything else has been up--even the loan market.

“We don’t think that’s going to happen again this year.”

Fixed-income asset managers and asset allocators identified three narratives that bond investors should watch as 2020 unfolds.

Continued Uncertainty On Trade
Though the U.S. and China signed “phase one” of a bilateral trade agreement this week, and Congress ratified a new North American trade pact, there’s still enough uncertainty around tariffs and trade to give pause to economic decision making, said Gautam Khanna, senior portfolio manager for BNY Mellon’s Insight Investment, where he manages more than $3 billion in core and core-plus fixed income.

“If you are in the boardroom at a large corporation contemplating making a capital investment, opening up a factory or a new line of business, you might be reluctant to do that in the face of not knowing what the tariff situation is moving forward, what our policies are likely to be and who is going to be in office,” said Khanna. “All of that uncertainty causes the investment portion of the economy to be a little less predictable.”

Elswick said that any further positive momentum on trade agreements could force yields upward and buoy riskier assets like equities, which would be a negative for rate-focused bond investors in Treasurys and other investment-grade sectors of fixed income.

Threading The Needle On Monetary Policy
Jon Adams, senior investment strategist with BMO Asset Management, believes that central banks will remain accommodative throughout 2020.

“We think that the Fed has made it clear that the bar to hike interest rates is very high,” said Adams. “We would need to see a move above the 2% rate target. The bar is actually pretty high both to hike and to cut, but it’s higher to actually hike. We think you need a significant uptick in inflation expectations for the Fed to move, and we don’t see a case for that.”

Khanna and Elswick also expect the Fed to be on hold throughout 2020, barring any surprise policy moves.

That may be best for investors, said Randy Swan, founder and lead portfolio manager at Swan Global Investments, where he runs $4 billion of hedged equity strategies.

“Every time central banks try to do something, something else goes bad,” said Swan. “Central banks are really just going to be reactive to what markets are pushing them to do.”

Swan mentioned that he isn’t recommending anyone allocate to fixed-income instruments in 2020, as projected fixed-income returns will barely be enough to clear inflation. “I don’t see the upside,” he said.

The Elephant, or Donkey, in the Room
The most concerning narrative for 2020 surrounds the upcoming U.S. presidential elections.

“I think the U.S. elections are a wildcard,” said Elswick. “We do see that the markets, both the bond and equity markets, are really beginning to focus on the upcoming elections. I’m not smart enough to attempt to think through all the issues, but I think the election year is most likely going to create a scenario where volatility perhaps rises--which isn’t exactly going out on a limb because volatility is very low today.”

Trade and central bank policy may depend on who the candidates are moving forward, and the prospects for a second term for President Donald Trump.

But with just over two weeks until February 3’s Iowa Caucuses, the Democratic nomination has become a three- or four-person race, with much of the outlook for the rest of the year dependent on who becomes Trump’s eventual challenger.

Elswick, Swan and Adams said that investors should be concerned that Sen. Elizabeth Warren or Sen. Bernie Sanders becomes the Democratic nominee.

“If Warren or Sanders win the nomination, you’ll see pain in areas like pharma, technology and financials,” said Adams. “If we see a more moderate candidate emerge, we think the impact will be more muted.”

If Sanders or Warren emerge to challenge Trump, China might have cause to expedite a more comprehensive trade agreement, said Adams, viewing the current administration as more accommodative than one led by either of the two progressive Democratic candidates.

Nevertheless, Swan believes that the results of this year’s elections will probably be more of the same.

“You have to ask yourself, ‘Is it possible for one party to get the presidency and a supermajority in the Senate?’ And yes, it is possible but it’s not very likely,” said Swan. “Neither party can get their agenda done without a supermajority, so no matter who wins the election, it’s probably going to be more of the status quo.”