Seizing the Opportunity: Why Now Is the Time to Invest Big in Bonds

It’s no secret that last year is one that bond investors are looking to forget. After keeping rates at roughly zero for roughly a decade, the Fed finally made the decision to start hiking to combat rising inflation. And that sent bond investors running for the hills. Thanks to the inverse relationship between bond prices and yields, as the Fed raised rates, bond prices fell. By a lot, in fact. Last year, the Bloomberg U.S. Aggregate Bond Index fell by over 13%. This was one of the worst declines since the 1980s. Last year also set another record for the bond market. This was the first time in history that the bond sector finished down two years in a row.

So far, this year has been a bit of a mixed bag as well. While inflation has moderated, the Fed has continued to raise rates and indicate that it still may see more hikes on the horizon. The carnage has muted, with the benchmark—as represented by the iShares Core U.S. Aggregate Bond ETF (AGG) — is still down on the year when looking at price.

However, for fixed income investors, this could be the moment we are looking for. According to State Street, PIMCO, and other investment managers, bonds are offering an unprecedented opportunity not seen in nearly 15 years.

For starters, yields are now above historic highs. All in all, the Bloomberg U.S. Aggregate Bond Index has seen its yield surge from 2.5% in March 2022 to 4.5% today. However, according to State Street that jump doesn’t fully show how high bonds’ yields are historically. When looking at long-term trends, percentile information before the credit crisis, and yield-to-worst, bonds now have yields above their 30-year averages. PIMCO echoes this statement, with several subsectors of the bond world paying very attractive yields relative to their historic long-term norms.

Second, bonds with regard to prices are cheap, especially when compared to stocks. Thanks to a dip in prices over the last year, many bond segments are currently below par values despite no changes in credit quality. Bonds simply reprice themselves as rates rise to reflect new issues at high coupon payments.

However, equities remain overvalued. Data shows that despite recent earnings revisions, the S&P 500 is still trading above its 15-year norms for both price-to-earnings and price-to-book. Those stretched valuations and high bond yields work in concert to change the so-called equity risk premium. With the equity risk premium (ERP) now below the median of 3.16%, State Street data shows the stocks should have a poor decade ahead. In fact, data suggests that when the ERP is below the median, stocks should have a 10-year annualized return of just 3.11%. Bonds remain the better value on yield alone.

For fixed income seekers and those with large equity exposure, the current value in bonds should be exploited. On the one hand, we have yields now seen in years. On the other, we have a great pricing environment that should help the asset class outperform stocks over the next decade or so. Perhaps even better is that the Fed’s pace of hikes has started to slow and bonds haven’t reacted too heavily to the news.

To that end, now could be a wonderful time to load up on bond mutual funds and ETFs. Obviously, the previously mentioned AGG, Vanguard Total Bond Market ETF (BND), or Fidelity US Bond Index (FXNAX) make for a simple indexed way to add the bulk of the bond universe to a portfolio.

However, both State Street and PIMCO suggest that other opportunities exist within the current framework. Higher yields and returns could be had. This includes corporate bonds, mortgage-back securities, and short-term bonds. The following funds offer a play in these areas.

Bonds are still a huge value. Thanks to last year’s declines, current high yields, and equities overvaluation, the asset class should garner plenty of investor attention this year. Investors have plenty of opportunities and ways to add the asset to a portfolio.

Don’t forget to check all bond funds here