May 2, 2022
Weathering the Volatility Storm
There have been very few places to hide from the financial market volatility of the past few quarters. Seeking shelter from the storm has been almost impossible, as every sector of the fixed income market is in the red, and equities have been repricing lower. The tables below highlight the pervasive nature of the down trade. In actuality, diversifiers to riskier asset portfolios (instruments that have negative or low correlation to risk) were difficult to find as we went through the storm of geopolitical events, monetary and fiscal policy directional changes, and assets in every region searching for a bottom. The usual assets that exhibit diversifying behavior, like fixed income and gold (and even bitcoin), were all caught up in the broad repricing across asset types.
Fixed Income Factors Performance Ranking YTD (through April 26, 2022)
World Equity Indices: Performance Ranking YTD (through April 26, 2022)
The traditional haven of fixed income has been in the eye of the storm. The lack of protection from the violent change in Federal Reserve (“Fed”) policy and the overall richness of the asset class seems quite apparent with the benefit of hindsight. In September of last year, only 25 basis points worth of Fed tightening were priced into the market. Flash forward eight months to today, and 300 basis points of Fed tightening in 2022 is priced into the US curve. In addition, ten-year US real rates (nominal rates minus inflation expectations) have moved from a historically rich -100 basis points in the fourth quarter of 2021, to something more normal, and close to zero today—see below.
Restoring Fixed Income Value
Fixed income across sectors have repriced to a meaningful degree. Specifically, the front end of the US yield curve has over 300 basis point hikes priced in, while real yields have moved meaningfully cheaper over the past few quarters. Also, credit spreads, which were plumbing the lows late last year, have widened at the index level to 130 basis points for investment grade and 355 for high yield (from 90 and 270 at year end, respectively).
Though the extent to which is debatable, some degree of value has been restored to the US fixed income market. Where there were very few places to hide from cratering equity and other higher risk markets over the past six months, there is now a viable alternative. If the economy slows or the equity market corrects to the point that it impacts consumer behavior, the Fed will not be able to raise rates to the degree priced in, and fixed income should rally. If this occurs, fixed income, as it traditionally does, should act as a diversifier in a multi-asset portfolio. In addition, for those with equity portfolios who are eager to de-risk, fixed income can offer both ballast, and in some cases, an attractive alternative. Where there was no yield to be found anywhere a year ago, investors can now buy Business Development Companies (BDCs) or Closed-End Funds (CEFs), some of which are yielding approximately 8%; high yield corporates, which are yielding over 6%; and shorter maturity investment grade portfolios, yielding close to 4%. Times have changed, markets have shifted, and fixed income should once again offer diversification and potential value in a diversified multi-asset portfolio.