Summary & Key Takeaways
Regardless of your long-term view on bonds, Treasuries are beginning to look undervalued from a cyclical perspective.
The outlook for economic growth and inflation are suggesting Treasury yields should fall in the months ahead.
Along with bond market speculative positioning and investor sentiment, buying bonds may soon be a rewarding contrarian trade.
The bull case for bonds
Central to my asset allocation framework and decision-making process is the outlook for the business cycle. A simple yet highly effective way to manage capital. For months now the leading indicators of the business cycle have been pointing to a swift and prolonged downturn in growth, with the potential to culminate in recession sometime in 2023. Unsurprisingly, most asset classes have re-rated to reflect this reality. Stocks, commodities and nearly all high-beta and pro-cyclical risk assets have adjusted lower, whilst bonds and duration have too sold-off amid the highest inflationary pressures in decades. Welcome to a world of price discovery.
In markets, the best investment and trading opportunities arise from dislocations. If there is an asset class that has not yet reacted as one might expect from a slowing economy and potential recession, bonds are now looking like they may fit the bill. Clearly, there are a number of important and justified reasons why bonds have sold-off over this past 18 months. Primarily, near four-decade high inflation, aggressive central bank tightening and a material demand and supply mismatch bear much of the responsibility of this bond sell-off, and rightfully so. It doesn’t take a genius to figure out why it has been a terrible time to own bonds. However, I wonder if this sell-off has becomes a little long in the tooth. Have yields permanently decoupled from economic reality, or has this bond sell-off gone too far? Is there a dislocation here, an opportunity perhaps?