Who says bonds can’t be flashy?
Investing in the nearly $24 trillion U.S. Treasury market and other forms of government-backed debt could be a good bet next year, particularly if another recession hits, according to Truist Advisory Services.
The team studied the past four U.S. recessions and found that investors who avoided going out on a significant limb by investing in bonds backed by the American government (see chart) reaped relatively high returns.
Average returns on government-backed debt in the past four recessions beat out the returns on both investment-grade and high-yield “junk” bonds, where investors tend to be paid more to take on credit risks, including the threat of rising corporate defaults in a faltering economy.
That contrasts with the typically lower yields produced by Treasurys and agency mortgage-backed securities, which get lumped together into the “risk-free” category, since default risks would be covered by U.S. government backing, even though interest-rate risks aren’t.
“History has shown that during economic slowdowns, both investment-grade and high-yield corporate bonds have underperformed U.S. government bonds,” wrote Keith Lerner, co-chief investment officer, and the Truist strategy team in their 2023 outlook.
“Given our expectations of decelerating growth next year, we recommend an up-in-quality bias for fixed-income allocations entering 2023.”
After a historically bad 2022, yields across U.S. fixed-income have recently climbed to their highest levels in roughly a decade as the Federal Reserve has fired off rapid-fire rate hikes to attack stubbornly high inflation levels.
The 10-year Treasury rate
topped 4% in October, but has since fallen to about 3.6%, while its shorter 2-year
counterpart was near 4.4% on Monday. Investors have been watching a series of yield curve “inversions” as a sign that a U.S. recession likely looms.
Clouding the economic picture, however, has been continued consumer spending, a roaring labor market and strong wage gains, all of which could keep inflation elevated and force the Fed to get more aggressive in raising rates than had been earlier anticipated.
“Despite a robust job market and continued strength in consumer spending, the economy has never been so unloved as it is now,” said Bob Schwartz, senior economist at Oxford Economics, in a Friday client note, adding that a record number of economists expect a recession in the next 12 months, even though he thinks a recession isn’t about to appear “anytime soon.”
U.S. stocks posted their worst daily drop in about a month on Monday on fears that the Fed may need to stay aggressive in its course of rate hikes to tamp down inflation against the backdrop of a roaring labor market. The Dow Jones Industrial Average
lost 1.4%, while the S&P 500
shed 1.8%, ending at 3,998.84. The Nasdaq Composite Index
fell 1.9%, according to FactSet.
Lerner’s team expects the S&P 500 to keep within a range of 3,400 to 4,300 next year, which would be consistent with the average annual spread of 27% between a market high and low since 1950.