PERSPECTIVE3-5 min to read

Despite market volatility, bonds remain resilient investments over the longer term

As bond yields reach their highest levels since 2007, investors are facing a bond market sell-off that has sparked concerns and potential impacts on trillions of US dollars' worth of bond investments. However, amidst the short-term volatility, it is essential for investors to maintain a long-term perspective.

01/11/2023
bonds_time1

Authors

Neil Sutherland
US Multi-Sector Fixed Income

Bond yields are currently at their highest levels since 2007 and to put the recent sell-off in perspective, US Treasury returns have been the worst since 1787 when a fledging US Republic ratified its constitution. Bond bears in the short term could push yields on 10-year Treasuries over 5%. Still, we believe owning bonds over the medium and long term will reward investors well, both in an absolute sense and relative to other asset classes, including cash and equities.

In the wake of the recent bond market rout, it is important for investors with long-term outlooks to maintain their patience and stay committed to a long-term approach to interest rates.

Understandably, that could prove difficult as investors have watched yields on 10- and 30-year US Treasuries rise to their highest levels since before the Global Financial Crisis. The massive sell-off has the potential to diminish the trillion US dollars’ worth of sovereign and corporate bond investments that banks, insurers, pension funds and asset managers have amassed.

However, investing is a long game. Bonds remain a good bet for the medium and long term, given the economic environment taking shape. While inflation may be more elevated than the previous decade, yields - both real and nominal - on higher quality bonds now stand at their highest levels in 15 years and screen cheaply not just in an absolute sense, but also relative to other asset classes, particularly equities. Additionally, with growth and inflation slowing and the US Federal Reserve (Fed) at or approaching the end of the hiking cycle, historically this has been when investing in bonds has been the most rewarding.

Following the Fed’s September meeting, the narrative appears to have shifted away from falling inflation and potential interest rate cuts toward higher rates for longer, significantly higher supply and increasing term premium and risk associated with bonds. In response, yields on 10- and 30-year US Treasuries reached 4.75% and 4.88% in early October, respectively, their highest levels since 2007. If we look at forward market expectations of interest rates, they are not expected to drop below 4% over the next decade. Given all the political, economic and structural gyrations likely over the next decade, this appears a very aggressive assumption.

Investors should bear in mind some data points that support this outlook:

  • A yield’s starting point matters to returns: Even if yields rise, returns will likely be positive over a 1-year period for short and intermediate bonds (and can be significantly so if they stabilise or fall)
  • Value relative to equities is very cheap: Equity Risk Premium (earnings yield minus yields on 10-year Treasuries) sits at a 15-year extreme; bond values haven’t been this cheap compared to equities since 2007 (see figure belo).

Equity Risk Premium (30-day moving average)

Equity Risk Premium (30-day moving average)

Source: Bloomberg as of September 30, 2023. Equity risk premium is calculated using the S&P 500 Index forward earnings yield minus the 10-year Treasury yield. Shown for illustrative purposes only and should not be viewed as a recommendation to buy or sell any security.

  • Inflation and growth have peaked: While many expect a soft landing today, we expect lower growth and higher volatility in 2024
  • Historically, bond yields peak roughly 12-18 months after the first rate hike, which was in March 2022. Additionally, rates tend to peak before the Fed has completed the hiking cycle.
  • Risk assets (equities and corporates) have a negative outlook: Real yields sitting above 2% likely accelerates a risk-off approach

The trends we described earlier still show that bonds will remain a good bet for the medium and long term. Stress is understandable, but with a yearslong perspective, now isn’t the time to panic.

Important Information

The contents of this document may not be reproduced or distributed in any manner without prior permission.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.

Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.

This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.

Authors

Neil Sutherland
US Multi-Sector Fixed Income

Topics

Follow us

Contact Us

Level 33, Two Pacific Place, 88 Queensway, Hong Kong

(852) 2521 1633

Online enquiry: Please complete the web form below and we will reply as soon as possible.

Contact us

The investments mentioned in this website may not be suitable to all investors. The information contained in this website is provided for reference only and does not constitute any investment advice. Investors are advised to seek independent advice before making any investment decision.

Investment involves risk. Past performance is not indicative of future performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Please refer to the relevant offering document including the risk factors.

This website is intended for Hong Kong residents only. Non-Hong Kong residents are responsible for observing all applicable laws and regulations of their relevant jurisdictions before proceeding to access the information contained herein. Schroder Investment Management (Hong Kong) Limited is regulated by the SFC. The website (excluding Schroder Provident Plan related pages) has not been reviewed by the SFC.

The website is issued by Schroder Investment Management (Hong Kong) Limited.

Important notice: Schroders does not make unsolicited requests through emails, calls, messages, WhatsApp, WeChat, Facebook, Instagram applications. Any contact other than via Schroders’ official channels for personal or financial information is likely to be false and fraudulent. Please stay vigilant and refer to our Fraud Alert Notice for further details. If you have doubts about the person, platforms, websites or institutions that claim to be associated with Schroders, please contact us via (852) 2521 1633 and inform the local police.