Bonds Vs. Equities – The Unexpected Turn
There was an unprecedented murmur in the final weeks of 2022: 2023 was widely anticipated as the “year of the bond”. The economic shadow that fueled such predictions seemed legitimate during the initial winter months. However, the landscape rapidly shifted with an unprecedented demand for equities that kindled a global rally. This swift and strong avalanche dwarfed bonds, and unexpectedly rendered investors more bullish towards stocks than they have been for the past 24 years, according to SentimenTrader models.
Nathan Thooft, the Global Head of Asset Allocation at Manulife Asset Management, reflected this trend, stating, “As sentiment, technicals and the risk of recession got pushed further out, we moved from being underweight stocks to overweight”. Such a shift prompted Thooft to reduce credit exposure in favor of equity.
The Supposed Safety of Fixed Income
2023 was shaping up to be a promising year for fixed income. A combination of the Federal Reserve’s easing monetary policy, coupled with the conclusion of aggressive rate hikes, was forecast to initiate a bond rally and establish them as a safety net in the face of a potential growth downturn. Contrarily, the economic machine had other plans.
The economy executed a rare balancing act: simultaneously slowing inflation and spawning new jobs. With constant acceleration in growth and no recession in sight — even from the Federal Reserve’s perspective — the predicted bond rally failed to materialize. The surprising turn of events led to a reevaluation by several prominent strategists, with some admitting to erroneous predictions and others elevating their stock targets or discarding their recession forecasts altogether.
A New Outlook on U.S. Economy
A recent survey by JPMorgan Chase & Co. found more than half of its clients now believe in the ability of the U.S. economy to expand despite rapid rate hikes. These “soft” or “no landing” scenarios have prompted a shift in investment strategies, with a significant increase in investors planning to elevate their equity exposure at the expense of bonds.
This trend is already being reflected in market behaviors. Discretionary investors have boosted their stock purchases, mirroring the enthusiasm observed when the COVID-19 vaccine was announced in late 2020. ETF flows over the last three months display a significant favor for equities over fixed income, marking a stark contrast to the start of the year.
Bond Predictions – Not Entirely Wrong
Bonds have not completely failed to deliver. They have provided positive returns across the curve, and investors are enjoying substantial yields with minimal risk. However, the astonishing gains in the equity market — highlighted by a whopping 44% increase in the tech-centric Nasdaq 100 — have unexpectedly altered the relative performance dynamics.
Despite the market favoring a soft-landing scenario, uncertainty persists. Alex Brazier, Deputy Head of BlackRock Investment Institute, cautiously noted, “What the market’s now pricing is a soft landing — a lot has to go right for that, and the risks are in one direction.”
Analyzing Market Movements
There are several factors to consider while assessing this surprising shift. The full impact of the Fed’s rate hikes might take two or more years to permeate through the economy. The disinflation trend might be fleeting, driven primarily by dropping oil prices. Sky-high valuations of tech stocks may trigger a sell-off. However, as Brazier admitted, “What’s happened, particularly in the US stock market, has taken a lot of people by surprise.”
Jason Goepfert, Director of Research at Sundial Capital Research and SentimenTrader, suggested that this shift may be more than just a transient phenomenon. According to him, the only other times when the stock-bond sentiment divergence was this wide was in 2003 and 2009, both signaling the advent of new bull markets.
In conclusion, 2023 turned out to be the year of the equities, against all expectations. With bullish technicals, subdued volatility, and significant corporate insider buying, the equity sentiment remains high, indicating a potential ongoing dominance of stocks in the near future.
