2025 Outlook: Bonds Are Better Positioned

Text on screen: PIMCO

Text on screen: Kimberley Stafford, GLOBAL HEAD OF PRODUCT STRATEGY

Stafford: So we talked about this backdrop of uncertainty. How are we thinking about fixed income as an asset class over the next year?

Ivascyn: There's great value back in bonds. Probably the most important point. 

Text on screen: Daniel Ivascyn, GROUP CHIEF INVESTMENT OFFICER

FULL PAGE GRAPHIC – TITLE: Yield vs. 5-year forward return. The line chart shows bond yields, measured by the Bloomberg U.S. Aggregate Bond Index yield in the blue line, and forward 5-year returns, measured by the Bloomberg U.S. Aggregate Bond Index forward 5-year return in the green line, from 1976 to 2024. The Average yield since 2010 is 2.7%. Since late 2020, the yield (blue line) has risen significantly from around 1.1% to 5.1% as of January 13, 2025. Bonds’ 5-year forward returns have closely tracked bond yields from 1976 to around 2020. The chart suggests that bonds’ 5-year forward return forecast through 2025 may follow the same historical pattern. Additionally, the chart shows that for the period covered, the index’s bond yield had a 94% correlation with 5-year forward returns.

The yield you start with is a reasonable floor on the real or the actual yield you're going to achieve over a five-year period. In fact, correlations between starting yield and forward returns here in the United States are up approaching 95%. 

You can achieve in a simple and relatively uninteresting passive index, like the Barclays Aggregate Index, a 5% type return. And by expanding into other sectors of the market, even high-quality sectors of the market, you can get that yield up even higher than that in some instances.

So that type of return has historically looked attractive in an absolute sense relative to even an elevated inflation rate of two and a half or 3% instead of the one and a half to two that we grew accustomed to pre-COVID.

FULL PAGE GRAPHIC – TITLE: U.S. core bonds now out yielding cash again. The subtitle is U.S. core bonds now outyielding cash again. The line chart plots the U.S. 3-month Treasury bill yield (representing cash) in the blue line and the U.S. Aggregate Bond Index yield (representing core bond and measured as yield to worst, which is the lowest possible yield that can be received on a callable bond without the issuer defaulting) in the green line from January 2023 to January 13, 2025. Cash surpassed bond yields for the most part of 2023, except around January and September-October 2023. However, bond yields have outperformed cash starting around the fourth quarter of 2024 through January 13, 2025.

And that return has historically also looked very attractive versus either cash or equities to reasonable alternatives to investing in bonds. In fact, more recently, just I guess a few months ago, we finally achieved the situation where that relatively interesting Barclays Aggregate Index started to return more than the cash rate. For a while, the last few years, investors may have considered extending out the yield curve, but there was a cost to doing so with cash being the highest yield on the board, so to speak. 

But the bottom line is you now get paid to extend out the yield curve so you can lock in these attractive rates and pick up some incremental income along the way.

FULL PAGE GRAPHIC – TITLE: Historical S&P500 CAPE Ratio. The line chart shows the S&P 500 Index’s cyclically adjusted price earnings ratio in the blue line and the CAPE average ratio since 1995 in the broken red line. The chart covers the period 1995 to 2024. The CAPE ratio compares a stock’s price with its average earnings over time. A high CAPE ratio exceeding the average suggests that a stock price or an index of a basket of stocks is expensive. The CAPE average ratio for The S&P 500 Index for the 29-year period in the chart is 28. There were three instances when the CAPE ratio surpassed the average – in 2000, when the ratio reached its highest at approximately 43, around 2022 when it reached 38, and in late 2024 when it stood at 38, which suggests stocks in the S&P 500 Index remains historically expensive.

Then last but not least, probably the most important thing I can say today is that I think it's important to note, Under any type of reasonable long term valuation metric, equities look  expensive. When you've gone back over multiple decades of decades of history and you've seen these yields as a starting point, five, six, 7% high quality bond yields on a global basis versus equities at the multiples that they're currently trading at.

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I think investors can step back and just be comfortable with the fact that yeah, you know there'll be some ups and downs. But we really have a nice set up for an investor in a diversified portfolio of high-quality bonds.

Stafford: That’s great it is a tremendous environment for active managers to add alpha. So what are the sources of alpha that you're most excited about?

Ivascyn: Well, again, the first one of more macro nature is the fact that you just have less influence from central banks. Less volatility suppression. I think the second point is that there's a lot of room to take advantage of structural sources of inefficiencies in markets. And I think this is an important point. It's not tied to a macro forecast or a policy forecast. But the easiest way to generate active returns for end investors is to take advantage of the non-economic decisions of others.

And I think it's important to note, but it's also a huge structural opportunity for investors to do your own credit work.

Today, the gap is growing between what we internally believe is solid risk relative to how rating agencies may rate that risk. And again, that's going to create great lots of opportunity for credit selection.

So a lot of opportunity there, in addition to a lot of the other structural inefficiencies that we're looking to take advantage of here at PIMCO as well.

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Text on screen: PIMCO

Disclosure

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.  Equities may decline in value due to both real and perceived general market, economic and industry conditions.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.

It is not possible to invest directly in an unmanaged index.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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