The turmoil in the bond market that took place in October was one of the worst sell-offs in history, but as 2023 comes to a close, there is reason for optimism in fixed income heading into the new year.
According to Lawrence Gillum, chief fixed income strategist for LPL Financial, the bond market has only recently turned positive for the year. He outlined five reasons that suggest the current set-up bodes well for investors. The first reason being the end of the Federal Reserve’s rate-hiking campaign, which is expected to eliminate the biggest headwind for bond investors.
Gillum also pointed to the asymmetric risk-return profile for bonds, which is largely due to the higher “yield cushion” offsetting higher interest rates. He believes that these higher hurdle rates may decrease the probability of losses due to an increase in interest rates, while at the same time increasing the probability of annual gains.
The strategist also suggested that bond investors could see equity-like returns without equity-like risks. LPL Financial holds a base case for the 10-year Treasury to hover at 4.25%-4.75%, but maintains that a sustained drop in yields could lead to high single-digit or low double-digit returns in the next 12 months for fixed income investments.
Gillum believes that the present fixed-income landscape will open the door for income-oriented investors to generate income again. He said that investors don’t have to take on a lot of risk to meet their income needs, and for those concerned about still higher yields, laddered portfolios and individual bonds held to maturity are ways to take advantage of these higher yields.
As markets transition into a more normal rate environment, Gillum wrote that bond investors are in a good place as 2023 winds down. He acknowledges that there will be volatility, but believes the risk/reward for fixed income is as attractive as it’s been in some time.
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