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Fixed Income — Where to From Here?

April 7, 2023

After a difficult year in 2022, some investors have been asking: what lies ahead for the fixed-income market?

Modern portfolio theory has been built upon the premise that portfolio risk can be reduced through diversification — investing in assets that have low positive correlation or even negative correlation. Typically, stocks and bonds have had negative correlation — when the stock market falls, bonds provide safety.

However, in 2022, the stock/bond correlation turned positive, and both asset classes experienced significant declines. This prompted the question: Is the 60/40 portfolio dead? Regardless of the percentage of a portfolio’s allocation to equities and fixed income — 60/40 or 70/30, as examples — last year’s situation demonstrated that diversification isn’t always a sure thing.

Yet, consider that 2022 was largely an anomaly. The central banks aggressively raised interest rates to fight inflation — much faster and higher than many market participants expected. As a reminder, as interest rates rise, bond prices generally fall. And, since bonds started 2022 with such historically low yields, this led to significant volatility and repricing of the bond market.

Consider that since 1929, there have only been three calendar years when stocks and bonds were both down in the U.S. — it’s quite rare to see both decline in the same year (see Table 1).

So, Where to For Fixed Income? After many years of artificially low interest rates, yields needed to reset to higher levels. Last year saw a substantial adjustment within a very short period of time, which led to the significant repricing. However, history has shown that this variability generally smooths out over time. A look back at the returns for 10-Year U.S. Treasuries following large down years shows this mean reversion (see Table 2).*

As well, higher yields and the potential for lower volatility are expected to support fixed-income markets. At the time of writing, inflation continues to show signs of easing and the pace of policy rate increases appears to be slowing. Of course, prices could be driven lower and yields higher if economic conditions or fundamentals dramatically change, though it is unlikely we will experience hawkish surprises from the central banks similar to those seen in 2022. Even if prices do remain volatile in the short term, consider that yields are now at highs not seen in decades.1 Higher income, through increased yields, contributes to supporting total returns over time.

The information contained herein has been provided for information purposes only. Graphs, charts and other numbers are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information has been provided by J. Hirasawa & Associates and is drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. This does not constitute a recommendation or solicitation to buy or sell securities of any kind. Market conditions may change which may impact the information contained in this document. Wellington-Altus Private Wealth Inc. (WAPW) and the authors do not guarantee the accuracy or completeness of the information contained herein, nor does WAPW, nor the authors, assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Before acting on any of the above, please contact me for individual financial advice based on your personal circumstances. WAPW is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. ©️ 2023, Wellington-Altus Private Wealth Inc. ALL RIGHTS RESERVED. NO USE OR REPRODUCTION WITHOUT PERMISSION

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The opinions contained herein are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Wellington-Altus Private Wealth. Assumptions, opinions and information constitute the author’s judgement as of the date this material and subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. All third party products and services referred to or advertised in this presentation are sold by the company or organization named. While these products or services may serve as valuable aids to the independent investor, WAPW does not specifically endorse any of these products or services. The third party products and services referred to, or advertised in this presentation, are available as a convenience to its customers only, and WAPW is not liable for any claims, losses or damages however arising out of any purchase or use of third party products or services. All insurance products and services are offered by life licensed advisors of Wellington-Altus. Wellington-Altus Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. All trademarks are the property of their respective owners.