Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
The Investment World’s Dark Horse
Published Date : April 26, 2016
In Wall Street’s eyes, there are few things more troubling than uncertainty, which has been in no short supply during this current economic cycle. The severity of the recession, the slow recovery, atypical reaction of some asset classes and the level and degree of central bank intervention have all contributed to elevated concerns. One of the more unexpected developments over the last two years has been the behavior of bonds, which have acted as a dark horse, delivering returns that exceeded those of many equity asset classes.
While every economic cycle is slightly different, interest rates have typically begun to rise as the economy improves, and this usually occurs long before the Federal Reserve officially enacts policies to target interest rate increases. When this happens, the stock market generally wins the asset class race, generating superior returns compared to bonds. This time around, inflation has remained stubbornly low and sluggish economic growth has persisted causing central banks around the world to provide continual economic stimulus. Currently, interest rates are negative in thirteen countries as a result.1 Meanwhile, the U.S. economy has continued to recover and the Federal Reserve raised rates in the U.S. for the first time in nine years in December of 2015. Surprisingly, longer-term interest rates in the U.S. fell in response. To better understand why this was the case, it is important to understand the role the U.S. Treasury market serves in the global economy.
In the current global economic environment that is characterized by sluggish growth and uncertainty, the U.S. Treasury market serves two purposes. At present, it offers very attractive relative yields and also remains the primary safe haven asset class for global investors. In this environment we anticipate demand for Treasuries will remain robust and that, unlike previous cycles, the global economic outlook, not the U.S. Federal Reserve, will continue to dictate the direction of U.S. Treasury yields.
Volatility is likely to remain heightened with the global economic outlook cloudy and, while the equity market has the potential to deliver attractive returns, it is not without risk, especially during the latter part of an economic cycle. We feel maintaining an allocation to bonds is essential, even in a low yield environment, as we anticipate interest rates around the globe are likely to remain low for an extended period of time. While a yield of less than 2% may not seem attractive, the total return potential for bonds needs to be taken into consideration. This includes the coupon rate, or yield, as well as the potential price appreciation of bonds.
For many investors, winning the race is not as important as a slow and steady experience along the way. At Sand Hill Global Advisors, we strive to consider risk before return and maintaining an allocation to fixed income is an important part of dampening volatility and helping clients achieve their financial goals.
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