Rising like a Phoenix

Since the great financial crisis of 2008/2009, central banks have flooded capital markets with liquidity and inflated the aggregate balance sheet total to over USD 25 trillion. As a result, one of the most important asset classes – namely bonds – became so unattractive that it was virtually wiped out. Not only did investors have to do without risk-free interest rates, as key rates in the eurozone and Switzerland slid into negative territory and were close to zero in the US, but the yield curves were also pushed down massively. As a result, it was hardly possible to generate attractive risk-adjusted returns with bonds.?

Comeback of the bond market

The first three quarters of the year were enormously difficult for investors, as both the stock market and the bond market were under pressure due to inflationary developments. There were hardly any safe havens, with the exception of the US dollar, which gained massively against the euro, the British pound and the Japanese yen. Bond markets in the industrialized nations recorded setbacks of 10% to 20% year-to-date, depending on the benchmark index and maturity – bond prices have fallen while yields have risen. In fact, we are seeing a resurrection in fixed income. As such, government bond yields have risen significantly over the past two years. Investors can thus again earn a positive return on bonds, even if the Eurozone and Switzerland lag the US and UK markets (graph 1).

The example of US government bonds illustrates that the mantra “There is no alternative” (TINA) is a thing of the past: investors can park their money at an interest rate of over 4% per annum for the next two years and thus once again have a real alternative to liquidity or equities.

Higher expected bond returns

As described, equities and cash have received competition. It is therefore hardly surprising that the equity risk premium has actually fallen over the past two years, despite a correction in equity markets of over 20% (graph 2).

The implications go much further, however, as credit spreads have shrunk to record lows as a result of central banks' quantitative easing programs. In recent months, spreads have now widened as well, and investors are receiving higher risk compensation. Both factors – higher yields in government bonds and higher spreads – are again opening up more investment opportunities for investors. For medium- to long-term portfolio construction, this means that expected returns for the coming years are once again higher than two to three years ago.

In the current economic environment characterized by an increasing probability of recession, we nevertheless advise investors to be very selective in their exposure to investment grade bonds at the moment. We consider the high-yield segment to be unattractive.