1. The New York Fed has placed a roughly 40% probability that there will be a recession in the next 12 months, a trend that has been steadily increasing.
2. Higher economic risk and lower rate expectations has been positive for high-quality core fixed income, but it is not a good combination for lower-quality spread sectors. Valuations in high yield and other riskier spread sectors are at historically tight levels, offering little cushion in a spread-widening scenario.
3. Correlations to equites among higher-risk fixed income are also at historically high levels, suggesting a greater vulnerability to any risk-off environment.
4. Core fixed income still offers investor diversification benefits vs. equities with negative correlations to equity returns. Using 4Q18 as a recent example – investors reaching for yield too aggressively will be hurt in an equity drawdown scenario.
5. An outlook that includes Fed rate cuts and higher economic risk suggests higher allocations to fixed income. Core fixed income looks the most attractive when weighing risk-adjusted returns with diversification benefits.
*Source on all charts is Bloomberg.
This article was written by the team at Sage Advisory, a participant in the ETF Strategist Channel.
Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.
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