As recession looms, this ‘boring’ investment can earn stock-like returns with little risk
One of the world’s largest fund managers is urging investors to take another look at bonds.
Owning bonds may sound less exciting than holding stakes in Apple or Alphabet. But they look likely to deliver more bang for the buck in the face of a global recession.
“High-quality bonds offer potential for equity-like returns with less volatility and less downside risk than equities” said PIMCO CIO Daniel Ivascyn in a recent interview.
At a time when investors face the risks of a “hard landing,” he added, this asset class will earn investors the highest yield in more than a decade.
Bonds are typically much less volatile than stocks—they give routine payouts, and usually underperform the stocks when times are good, but do better when times are bad.
For this reason, historically a “balanced portfolio” would have around 40% bonds and 60% stocks. Although this formula fell out of favor in recent years as stocks surged and bonds lagged.
What hurt bonds since 2008 was central bank policy.
Following the financial crisis, central banks kept benchmark interest rates very low so companies only had to offer rates slightly higher than that to their investors to get cash—bad news for bondholders.
Then, central banks started raising rates in late 2021, which caused bond prices to fall—also bad news for bond holders.
In contrast, low interest rates were good news for stocks, especially those of fast-growing tech companies, which stormed their way to multi-billion dollar valuations.
Now, however, central banks look set to stop hiking interest rates, but still hold them at a high level. This means bonds offer both high payouts or yields to investors, and, because of the sell-off, prices are cheap.
From here, bonds will either continue to offer high yields or their prices will rise. Either way, good news for bondholders.
“The bond market’s massive repricing may allow investors to earn the highest real yields in 12 years without taking uncomfortable risk,” Ivascyn said.
When a recession eventually comes—and most economists think the global economy can’t get away without one—bonds are likely to outperform stocks.
“High-quality bonds pay us to wait”
Relative to bonds, the stock market is the most expensive in 20 years.
Combine that with a gloomy economic outlook and you get a surefire recipe for “very weak returns,” said Luca Paolini, chief strategist at Pictet Asset Management.
In fact, major stock benchmarks—including the S&P 500 and Nasdaq—are trading at their highest in over a year. If an economic downturn comes to pass, there’s plenty of room for downside.
Bonds, on the other hand, are cheap—and while a recession doesn’t bode well for higher-risk bonds, PIMCO suggests “focusing on high quality, less economically sensitive areas of the market.”
Over the next few years, Ivascyn says, the fund expects to snap bargains in riskier market corners. But, until then, “high-quality bonds pay us to wait,” he says.