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After a horrendous 2022, bonds look poised for a better year in 2023. We think high quality bonds and their income potential could help portfolios overcome volatility in the year ahead.
By Jason Zhang, Portfolio Manager, SLGI Asset Management, Inc.
2022 has not been kind to bond investors, but we see a few important silver linings after the volatile ride. Following the sharp rise in interest rates over the year, valuation of bonds has improved significantly. Investors who were starved of yields for years should welcome the change, as they no longer must own long duration bonds or lower credit quality bonds to earn a decent yield. Given the looming economic challenges, we think income can play a pivotal role in an investment portfolio as higher-quality bonds have turned advantageous.
We believe that long-term interest rates are in the process of peaking, and that there is limited downside to high-quality bonds. We see increasing signs of inflation moderating as global economies slow due to rapid interest rate hikes around the world. We believe that most of the painful monetary tightening exercises and falling bond prices are behind us. Central banks will soon be able to pause interest rate hikes and assess how quickly inflation can return to their targeted levels. Importantly, we think that central banks will have the flexibility to respond in measured steps to a possible economic slowdown. We also think a return to the ultra-stimulative policies of the post global financial crisis era is highly unlikely. This is all good news for high-quality bond investors.
To be clear, bond yields will not decline in a straight line. We expect some volatility along the way because one of the key tools to fight inflation – higher interest rates – also slows consumer spending, corporate investments and hiring. This ultimately dampens demand for goods and services and brings down price pressures in the economy. However, in a volatile market, when asset prices recover and bond yields decline too much, inflationary pressures could rebuild. This pickup in inflation could then causes bond yields to increase again.
From an asset allocation perspective, the reallocation between stocks and bonds is a key tactical decision in 2023. We like the idea of adding bond exposure in the coming months, at better entry points. We think overweighting high-quality bonds initially makes sense. Investors will be rewarded for their patience in waiting to add equity exposure as we believe corporate earnings could be revised downwards, a necessary condition to make stocks a better bargain.
The views expressed in this article are those of the authors and are subject to change at any time. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by SLGI Asset Management Inc. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy.
