Navigating Turbulence:Everything That You Need to Know About Bonds

Bond Positioning and the Current Market Landscape: Key Considerations

It is a bleak outlook in the realm of U.S. bonds.

U.S. Treasuries suffered a 17% decline last year, marking the poorest return in over two centuries. They appear to be heading for their third consecutive year of losses, a phenomenon unprecedented in American history. This situation somewhat echoes the state of equities around the same period last year.

Financial assets have experienced a notable upswing in recent days, with both stocks and bonds exhibiting strong performances.

The Treasury's move to alter its issuance strategy, favoring shorter maturities contrary to market expectations, triggered a bond rally. Stocks followed suit, benefitting from lower yields, and revealing a positive stock-bond correlation that resonates with multi-asset investors.

Although bonds seemed to have the upper hand, the stock-bond ratio declined, typically suggestive of an economic slowdown. Despite this, there are compelling indications that this trend might be short-lived.

While the economy might display signs of weakening in the short term, leading indicators suggest the possibility of narrowly avoiding a recession. As a result, the stock-bond ratio is expected to resume its upward trajectory soon.

For instance, consider the latest data on payrolls. While monthly data can be noisy (with expectations of a 180k change in October versus 336k the previous month), the annual growth rate has been steadily declining throughout the economic cycle.

On the other hand, jobless claims, which provide a lead time of three to six months on payrolls, have recently stabilized, indicating a likely stabilization of payrolls early next year. Other leading indicators, such as the Conference Board's Leading Index, also support this projected trend.

Overall, there has been a noticeable decline in S&P revenue growth, posing a significant challenge for stocks as current returns rely on both sales and multiple expansion.

However, the future prospects appear more optimistic than the present situation suggests, with leading data indicating an impending turnaround in revenue growth.

The stock-bond ratio typically mirrors the inverse movement of the unemployment rate. In other words, when unemployment increases, the ratio tends to decrease. Consequently, it might encounter further obstacles in the near future. Nevertheless, if the leading data's projections hold true and a recession is averted, the ratio is expected to resume its upward trajectory.

Chart: MS

In terms of positioning, the current landscape appears to be reaching a critical point. Leveraged funds are currently positioned at their maximum short levels, indicating a strong bearish sentiment in the market.

On the other hand, asset managers still have the capacity to increase their positions, suggesting that there might be further room for market participation and potential adjustments in the near future.

How are we positioned?