North America looks particularly attractive right now, according to fixed-income expert
While the inhospitable economics of 2022 created a challenging investing environment across asset classes, it’s also created the best opportunity for bond fund investors in a decade, according to one fixed-income expert.
“It's a pretty good opportunity for bonds across the across the board,” says Mark Wisniewski, partner and senior portfolio manager at Ninepoint Partners.
As Wisniewski notes, the hyper-aggressive anti-inflation campaign by central banks last year – which saw interest rates ascend sharply to a level unseen in years – brought down valuations across the asset spectrum. But with inflation appearing to cool from its multi-decade highs, policymakers are likely to ease off the accelerator, which should provide some relief to the markets.
Another positive: 2022’s upward moves in interest rates have revived yields on bonds. Compared to just a year and a half ago, when income-focused investors needed to go far out on the duration spectrum, a government bond on the shorter end of the curve now offers up to 4% yield in Canada. Corporate bonds are even more compelling, with yields for securities of an equivalent duration fetching up to 8%.
“Interest rates have gone up everywhere. But certainly when you look at Europe or Asia, they haven't gone up as much as they have in North America,” Wisniewski says. “I would say North America looks particularly attractive right now.”
One potential outcome for 2023, he says is that securities will move back to par, resulting in more capital gains-driven returns versus income. The upshot will be more tax-efficient gains for bond fund investors – but that will depend on central banks’ next move.
“We’ll see capital appreciation on securities if interest rates go lower,” he says. “Because central banks were so aggressive in raising rates, there’s a fairly high degree of certainty that we’ll get a recession this year,” Wisniewski says. “I don’t know whether that will happen mid-year or at the end of the year. But if we do get recession at some point, central banks are going to stop raising rates.”
Even if they don’t actually see policymakers stop hiking, Wisniewski argues that a strong consensus of rate hikes being over, setting the stage for rate cuts, will be enough to spark a rally and drive capital appreciation in fixed income. But even if the BoC and the Fed don’t cut interest rates, or interest rates go sideways, he says yields today are enough for investors to make a healthy return on their fixed-income holdings.
While a recessionary scenario could create some upside in fixed income, there are still risks to steer through. In case the BoC’s rate-hiking drives the country into recession and unemployment rises, it could put pressure on corporations. Wisniewski says investment-grade corporate bonds are priced for a soft landing, and a hard landing could cause spreads in that space to drift wider.
“I think in that scenario, high yield is much more vulnerable,” Wisniewski says. “Investment-grade is relatively cheap, and it correlates more with moves in interest rates.”
A hard landing would lead interest rates on the longer end of the curve to collapse. Keeping that in mind, Wisniewski says longer-term government bonds and investment-grade credit would do relatively well under a hard-landing scenario.
“If you ask me, I think fixed income is going to be the best opportunity for investors in 2023,” he says.
