Fixed Income Monthly Report - January 2023

Preview of our monthly publication with macro themes and single bond ideas

Every month, we publish the Fixed Income Monthly report. The report is a synthesis of the Ashenden’s team view on Fixed Income, pursuing a global approach through the full spectrum of the asset class and providing bond picks. We range from Investment Grade bonds to High Yields & Emerging Markets.

In the report we disclose our bond model portfolio (6 years track record) with more than 60 individual names. We include new single bond ideas, switches, new entries and exits.

All this is corroborated by a bottom-up analysis for each single position (new and old) and merged with a top-down consideration so to include the key market drivers.

This is one of the research piece our team produces internally. The intent of the report is to support wealth managers/asset managers in their decision and allocation process.

Underlying you can find a summary of what you can find inside this rebort.

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January edition content

2022, a year of pain and no gain

2022 will be remembered as the worst year since 2008, impacting virtually every asset class from stocks to fixed income. Given the high correlation, any diversification strategy put in place did not work. The rare place of safety was the energy sector which had its biggest yearly gain ever with a +59%!

The impact of monetary policy on market conditions was clearly displayed, highlighting the market’s deep reliance on low interest rates and ample liquidity.

All around the world, central banks raised interest rates for the first time in years to stomp out surging inflation. The Russian invasion of Ukraine and China’s draconian Covid-zero policies threw markets and supply chains into further disarray. Other headwinds formed – an energy shock, a strong US dollar, a softening consumer, slowing money supply, and corporate cost cutting initiatives including layoffs – to name a few.

In retrospect, we can now say that in 2022 both stocks and bonds were overvalued, but the speed and magnitude of central bank rate hikes – none more important than the Federal Reserve – shows how badly the market was caught offside.

After injecting financial markets with $120bn per month in liquidity via asset purchases for nearly two years, the Federal Reserve increased the federal funds rate by 4.25% from March 2022 to the end of the year.

This was the fastest acceleration of interest rates in terms of magnitude and pace since 1980 and 1981.

• Mortgage rates doubled on a year-over-year basis for the first time ever

• Mortgage applications and refinance activity declined to historically low levels

• 20+ year Treasuries underperformed stocks throughout the year

• The 60/40 portfolio of stocks & bonds generated a return of -18.3% (third-worst year on record)

• Interest rate inversions occurred across the entire yield curve

• Tech plummeted: Apple, Amazon, Google, Microsoft, Facebook/Meta, and Tesla, the cumulative market cap fell by approximately $4.7 trillion in 2022

• Bank of Japan abandoned a policy of Yield Curve Control – something the US Treasury and the Federal Reserve had done as long ago as 1951

To recap, in 2022 the S&P 500 fell -19.4%, coming just shy of the -20% mark that only 6 other years since 1928 have seen. While the Nasdaq was down 32.5%.

On the bond side the LQD, one of biggest Investment Grade bond ETFs was down 20%, while the popular High Yield ETF (HYG) “only” down 15%: the overperformance can be explained by the lower duration in HYG compared to LQD and by the record number of rising stars that got upgraded to IG status in 2022.

As rates increased, bond prices got crushed to the point where they put up the second worst year ever on record, but can now be considered a good alternative to the stock market. Indeed, investors can now find good absolute yield everywhere across credit and bond markets.

2023, bonds are an attractive asset class

The dance between the Federal Reserve and financial markets, specifically the bond market, continues. With the Fed undertaking its most aggressive tightening campaign in decades, this is the key factor that will impact the economy and markets over the year ahead.

The economic impact of these rate hikes is clear – lower growth, and the chances of a significant recession are important. With much of the Fed’s tightening occurring over recent months, the full impact of the Fed’s tightening is yet to be felt.
As the US is likely to experience a slowdown, it is reasonable to presume that US corporate earnings will also decline, despite fairly buoyant consumer spending and low unemployment.

In the bond market, a key measure of inflation expectations paints a rosy picture – one in which prices drop and settle at the Fed's 2% target in short order. As global macro trends temper inflation this year and central banks slow (or pause) their rate hikes, bonds could be one of the winners of 2023. This is particularly true for high-quality bonds, which historically have performed well after the Federal Reserve stops raising interest rates, even when a recession follows.

While bonds have been especially volatile of late, there are signs that these swings are peaking. Higher yields have also reduced the duration risk for fixed income assets at the same time that economic growth is becoming more of a concern. That all suggests that risks are piling up for the equity market next year while bonds might become less risky.

We expect that as 2023 progresses, opportunities to increase portfolio risk will evolve. We see potential for bonds to be less positively correlated with equities later in 2023 and provide more diversification benefits.

Next, we updated our monthly model portfolio, studying its performance and adding new bond ideas:

• New ideas

• Ideas reiterated and business case updates

• Exits

The fixed income model portfolio includes Investment Grade and High Yield bonds.

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