Capitalizing on the Inverse Stock-Bond Relationship with Multi-Asset Portfolios
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Erin: As inflation and growth appear to be moderating over the cyclical horizon, the traditional negative relationship between stocks and bonds has re-emerged, which is highly supportive of multi-asset portfolios today.
Text on screen: Erin Browne, Portfolio Manager, Asset Allocation
Equities and bonds serve as a complement to each other, and we expect both asset classes to benefit in our baseline economic outlook for a soft landing amid continued central bank rate cuts. The return of the inverse relationship between equities and bonds enables better diversification across asset classes and allows us to position multi-asset portfolios to target attractive returns while limiting risk.
Investors are also considering the potential impact of U.S. policy under the second Trump administration. We expect bond yields to remain attractive amid this leadership transition
Text on screen: Within equities, we favor U.S. companies that are less reliant on imports
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and within equities, we favor U.S. companies that don’t rely as heavily on imports, as well as those likely to be buoyed by deregulation and more favorable tax policies.
Text on screen: Emmanuel S. Sharef, Portfolio Manager, Asset Allocation
Emmanuel: Currently, we are focused on the benefits of having both stocks and bonds in PIMCO’s multi-asset portfolios. And this is important because during past rate-cutting cycles in soft landings, we’ve actually seen good performance from both asset classes.
Now, if we look through factor and sector lenses, there are several takeaways from history: after the first rate cut, growth stocks usually do better than value stocks, large companies tend to outperform smaller ones, and stocks with good dividend yields and quality characteristics often see positive returns within six months.
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Sectors like technology, healthcare, and consumer staples generally outperform, while energy, communications, and financials lag.
Regionally, we maintain a preference for the United States. US stocks have a solid track record of delivering positive returns during soft landings, and we’re also expecting the market to broaden beyond just the Magnificent 7.
Erin: Turning to fixed income, bond returns have been positive during Fed rate-cutting cycles across a range of macroeconomic environments. As central banks continue with policy normalization, we believe fixed income should benefit from capital appreciation.
Furthermore, the starting yields of high quality core fixed income are strongly correlated with five-year forward returns, meaning today’s attractive starting yields bode well for future return potential.
High quality bonds also offer downside mitigation in the event of a hard landing. In multi-asset portfolios, investors can seek higher risk-adjusted returns by stepping out of cash and onto the yield curve, adding to duration exposure.
Text on screen: High-quality securitized credit and mortgages can enhance yields and diversify portfolios
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We think high quality credit, specifically securitized credit and mortgages, can enhance yields and also serve as a diversifier. In particular, agency mortgage-backed securities appear attractively valued, with spreads over U.S. Treasuries near historical highs, making agency MBS a highly liquid alternative to more richly-valued corporate credit.
We think it’s important to hedge against upside risks to inflation amid high fiscal deficits, geopolitical risks, and potential trade policies and deglobalization trends that could push inflation higher.
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To this end, we see inflation-linked bonds as an attractively priced hedge.
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Emmanuel: In addition to using PIMCO’s forward-looking macro views and detailed bottom-up research, we also rely on quantitative methods to identify inefficiencies and structural alpha opportunities in equity markets.
We use a disciplined, systematic process based on four main themes: momentum, growth, quality, and value. And these themes are based on traditional metrics, like earnings growth, but also alternative data—like earnings call transcripts and customer-supplier relationships.
Text on screen: We score stocks on four themes to generate a composite attractiveness score
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Using that data, we score each stock based on these four themes, which gives us a single composite score for each stock that reflects the overall attractiveness of the company.
So rather than picking stocks, we think this systematic equity strategy based on a quantitative approach and advanced analytical tools can deliver a more consistent path of excess returns throughout different market environments.
Text on screen: With central banks normalizing monetary policy, we expect both equities and bonds to perform well
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Erin: Overall, we see a compelling backdrop for multi-asset portfolios today. As central banks continue to normalize monetary policy amid an outlook for a soft landing, both equities and bonds are poised to position well.
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Magnificent 7 consists of Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta, and Tesla.
High quality core fixed income correlation is based on the Bloomberg U.S. Aggregate Index.
References to liquidity refer to normal market conditions.
Disclosure
Past performance is not a guarantee or a reliable indicator of future results.
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. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Mortgage- and asset-backed securities (MBS) may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee, there is no assurance that private guarantors will meet their obligations. References to Agency and non-agency mortgage-backed securities refer to mortgages issued in the United States. Equities may decline in value due to both real and perceived general market, economic and industry conditions. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. An option is a type of derivative. A derivative is a security whose price is dependent upon or derived from one or more underlying assets; the derivative itself is merely a contract between two or more parties. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss.
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. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. There is no guarantee that results will be achieved.
Alpha is a measure of performance on a risk-adjusted basis calculated by comparing the volatility (price risk) of a portfolio vs. its risk-adjusted performance to a benchmark index; the excess return relative to the benchmark is alpha. Beta is a measure of price sensitivity to market movements. Market beta is 1. Correlation is a statistical measure of how two securities move in relation to each other. The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility.
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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