The threat of recession is making debt securities a safer bet, while the stock market is yet to price in those risks.
That’s the view of some fund managers and strategists from JPMorgan Chase & Co. to UBS Group AG and Morgan Stanley, who now prefer fixed-income instruments to equities. The argument is that bonds, particularly higher-rated ones, will be able to better weather any economic slowdown, whereas stocks would suffer more if the Federal Reserve fails to navigate a soft landing.
They have numbers to support their convictions. One is the amount by which yields of high-grade dollar bonds exceed dividend yields of companies in MSCI Inc.’s ACWI Index. That gap has widened almost 90 basis points in the past year and remains near the peak in March that was the highest since 2008 during the global financial crisis. Buying bonds now offers investors extra yield and they can benefit from capital gains if interest rates drop.
Risks in equities are in the spotlight after a selloff in US regional lenders Tuesday fueled renewed anxiety over financial stability, sinking stocks. The flight to safety boosted bonds. Two-year rates, which are sensitive to imminent Fed moves, plunged as much as 21 basis points to below 4%.
That cut year-to-date returns for global equities to about 7% versus 3.3% for investment-grade debt. Equities valuations are still above their 12-month average, making them look pricey to some investors.
“I do think the opportunity overall still favors fixed income at this point,” Tai Hui, JPMorgan Asset Management’s chief Asia market strategist, told Bloomberg Television. “For equities, valuation for the US is still not particularly cheap and I think earnings expectations are still too optimistic.”
Corporate debt faces risks too, of course, in a volatile market. If lingering inflation keeps interest rates high, that may bring about a recession that leads to more companies collapsing. And any economic slowdown could add strains in global junk bond markets, which are more sensitive to default risks. Some are still reeling from problems with real estate debt, like in China.
Still, the broader macro picture has some observers preferring bonds overall at the moment.
The price-to-12-month-estimated-earnings ratio of MSCI ACWI Index shares has climbed to about 15.8 times its projected earnings, a jump from 13.4 times at the end of September. That comes at a time when economists see the probability that the US will enter a recession over the next 12 months at 65%, compared with a reading of 25% a year earlier, according to a Bloomberg survey.
Meantime, net short positions on S&P 500 futures rose to a dozen-year high, indicating strong market expectations that shares are headed lower.
UBS has raised bonds to its most preferred asset class and lowered equities to the least preferred, according to Hartmut Issel, head of APAC equity and credit at UBS Global Wealth Management.
“Investors should lock in yield in investment-grade, high-grade and emerging markets sovereign bonds, and consider more selective equity exposure in emerging markets,” Issel told Bloomberg. “High-grade and investment-grade bonds still provide some protection against recession risks despite the recent moderation in yields.”
Some investors think good opportunities remain in the global share market if one looks carefully enough, including emerging markets.
“There are still some bright spots, it just requires more assessments and more careful research by investors” in the equity market, said Hebe Chen, an analyst at IG Markets Ltd. in Melbourne. “I don’t reckon giving up the risk in equity fully and go into the fixed income asset.”
Still, others say that stock bulls may be misreading market-affecting developments. Equity investors have been seeing potential interest-rate cuts as simply a cost-of-capital signal or an indicator that inflation has been tamed, as opposed to a sign that economies are weakening, according to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.
“Stock investors have to cope with the fact that multiples may contract at the same time that earnings begin to fall,” Shalett said on Bloomberg Surveillance. “That’s a very kind of dangerous combination.”
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
