The world’s largest active bond manager says rising yields and heightened economic uncertainties under President-elect Trump make fixed income investments better positioned going forward.
This is according to a recent note from Pimco chief investment officer for global fixed income Andrew Balls and economist Tiffany Wilding, who said Trump’s election increases global economic uncertainty in 2025.
“The incoming administration’s protectionist proposals have the power to reshape trade relationships and alter economic dynamics worldwide,” the pair said.
In this environment, they said the range potential outcomes has widened: with both brighter upsides and bleaker downsides.
This means that fixed income investments “present an appealing opportunity in both the near term and over a longer horizon,” the pair said.
“We believe bond yields are attractive at a time when equity valuations and credit spreads are not, giving high quality fixed income a favorable starting point,” they added.
“Unlike cash, bonds stand to benefit from capital appreciation as policy rates fall, enhancing bonds’ role as a diversifier and stabilizer for equity exposure in portfolios.”
For the stock market’s current momentum to continue, the pair said it would require valuations to remain high well above long-term norms, but bonds “simply need historical trends to hold to generate attractive returns in line with starting yields”.
“Bond market returns can be further enhanced by capital gains in adverse macroeconomic or market scenarios,” they added.
“Looking back at bond and equity markets on average since 1973, during similar periods when US core bonds are yielding around 5% or greater while US equities’ earnings ratios are around 30 or higher, bonds have offered higher five-year subsequent returns, and with potentially lower volatility.”
Although they expect to be overweight duration after the recent rise in yields, they believe yield curves should gradually steepen as a result of central bank easing and rising term premium.
As such, Pimco is underweight “the 30-year area of the US yield curve” and overweight in the “five- to 10-year maturity range”.
The pair also pointed to US Treasury Inflation-Protected Securities (TIPS) as a “reasonably priced hedge” against higher inflation outcomes.
Selectivity required in credit
When it comes to corporate bonds, tight credit spreads are discouraging some investors from taking additional risk.
Although the pair expects corporate credit “can continue to do fine”, they favour high-quality bonds and maintaining liquidity.
As such, Pimco favours structured products, the investment grade credit default swap index and high quality investment grade credit versus lower-quality.
“Given broadly tight credit conditions, we are shifting focus beyond global market-weight spread allocations toward high quality spread in harder-to-source areas,” the pair said.
“U.S. agency mortgage-backed securities (MBS) remain an attractively priced, high quality, and more liquid alternative to corporate credit.”
They are more cautious on lower-quality, floating-rate debt outstanding in corporate markets and noted “a trend toward more aggressive financial engineering in some corporate credit areas”.
However, the pair said “this is creating opportunities to use independent credit analysis to identify potential gaps involving perceived credit fundamentals and ratings”.
When it comes to private credit, the firm prefers asset-based lending, “specially assets tied to higher-quality developed market consumers and residential mortgages”.
