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Have investors missed the rally in stocks and bonds?
Karl Zeile
Cheryl Frank
November 4, 2024
A little over a year ago, our CEO, Mike Gitlin, wrote about the significance of the end of the Federal Reserve’s rate-hiking campaign — and the opportunity it presented to investors. The article looked to history for hints of what it might mean for stock and bond markets, noting that as the central bank pivoted, returns were strong. We suspected that moment would also be a turning point for markets, which had experienced a very rough 2022. Those who acted boldly and got invested at that time likely feel good about having moved some cash holdings into stock and bond investments.
A 60% equities/40% fixed income portfolio would have gained more than 26% over the twelve months ending 30 September 2024, using the S&P 500 Index for equities and Bloomberg US Aggregate Index for fixed income as proxies. Each market separately also far outpaced the 5% or so a cash-like investment in a certificate of deposit (CD), as represented by Bankrate.com’s US one-year High Yield Savings Rate, might have provided. The lesson learned is clear: Investing is about taking a long-term perspective in pursuit of long-term goals. For those who may have missed that upside, has the opportunity passed? We don’t think so.
Stocks, bonds and the 60/40 blend far outpaced CDs
Past results are not predictive of results in future periods.
Source: Bloomberg. Index returns as of 30 September 2024. One-year CD rate represents the hypothetical return a locked-in certificate of deposit would have provided if locked in for 12 months based on Bankrate.com's US one-year High Yield Savings Rate as of 30 September 2024. The 60/40 blend shown represented by 60% S&P 500 Index and 40% Bloomberg US Aggregate Index.
The Fed is just getting started, and bonds should benefit
The US central bank has made its path forward crystal clear: It is in rate-cutting mode. Monetary policymakers in the United States surprised many investors in September with an aggressive 50-basis-point cut in its policy rate, rather than a more modest 25. It has projected another 50 basis points of cuts this year and an additional 100 in 2025. The market expectation is slightly lower, predicting roughly 125 basis points of cuts over the next five quarters, as of 28 October 2024. Many other major developed market central banks have also begun cutting as inflation pressures wane.
With bond yields lower than a year ago, those who were not invested may worry that they have missed out. Fortunately for investors, recent increases in rates provide another entry point, and history has shown that potential upside for bond investors persists following the start of Fed cuts. To be sure, past performance is not necessarily predictive of future performance. But historically, while bond yields declined in the period before the first cut, they continued to fall after that key pivot as well.
Bond yields have continued to fall after the first rate cut
Sources: Source: Capital Group, Bloomberg. Figures reflect averages from seven rate-cutting cycles initiated by the US Federal Reserve with data from May 1984 to December 2019.
Declining yields are a key tailwind for fixed income returns, since bond prices rise when yields fall. That is a major reason why bond returns were so strong over the past year. The two- and ten-year US Treasury yields were down 140 and 79 basis points over the 12 months ending in September. Markets began to anticipate Fed cuts, yields moved lower across the Treasury curve, and bond returns benefited. As the Fed continues cutting, history suggests that yields could continue to drift down. Of course, if the US economy hits an unexpected soft patch, the Fed could cut even more aggressively to combat rising unemployment. Importantly, rising bond prices are only one component of total returns in fixed income — and current market yields offer investors compelling income opportunity across a range of fixed income investments.
Here, investors could consider a high-quality bond fund with a moderate duration (a measure of interest rate exposure). Such a position would seek to take advantage of attractive current yields and the potential for capital appreciation as yields fall, while also providing diversification from equities if faced with unanticipated volatility. There are multiple paths to strong fixed income returns. If the Fed cuts more gradually from here, yields across corporate, securitised and other sectors could remain attractive relative to levels over the past decade. And if a soft landing is achieved, credit should thrive.
Some stocks have become expensive, but we still see opportunities
We are seeing some mixed signals in markets, but at this point it looks like the Fed has managed to usher in lower inflation without jarring the economy into recession. Its cuts may help to reduce discount rates and provide some support for today’s high equity valuations. However, our portfolio managers are being selective and relying on our analysts’ fundamental research on sectors and companies.
For example, some of the largest 50 or so companies continue to dominate indices. Yet recent valuations and projected earnings indicate that growth may slow for some companies, specifically for the Magnificent Seven (Apple, Microsoft, Amazon, NVIDIA, Alphabet, Tesla, Meta).
Given this broadening of the markets, a few areas, such as aerospace equipment and biotechnology, may be of particular interest to investors. Travel has recovered to pre-pandemic levels, and a nearly decade-long backlog of passenger aircraft remains to meet the growing demand for air travel. For biotechnology, we are finding select companies developing gene therapies and other innovative treatments to address previously difficult to treat conditions.
Opportunities exist even in a narrow market
Past results are not predictive of results in future periods.
Source: FactSet. As of 31 August 2024. Forward P/E (price to earnings) ratio represents the forward P/E ratio for the current fiscal year. A higher forward P/E can indicate an undervalued stock and/or that investors think there will be significant future growth. A lower forward P/E can represent the opposite. Estimated earnings growth is an annual growth figure. Magnificent Seven stocks were the top seven contributors to returns for 2023 in the S&P 500 Index.
The infrastructure required to build out data centres for artificial intelligence is an area of interest. The power needed for those data centers and growing penetration of electric vehicles is increasing electricity demand for the first time in 20 years. As power production rises while transitioning away from coal-powered generation, we see increased demand for nuclear power generation, natural gas generation, and batteries to increase the reliability of wind and solar.
Given this backdrop, we seek to target the right sectors and companies we believe will continue to produce strong relative returns. On a path of positive economic growth, we expect holdings to thrive.
Act in the short term to embrace the long term
Looking ahead, our investment team continues to see promise both in stocks and bonds. This should not surprise experienced investors. History shows that over longer periods, stocks, bonds and a 60/40 portfolio also outpaced long-term averages — and cash — following the end of the Fed’s hiking campaign.
After Fed hikes ended, long-term results outpaced cash and historic averages
Past results are not predictive of results in future periods.
Sources: Capital Group, Morningstar. Chart represents the average returns across respective sector proxies starting in the month of the last Fed hike in the last four transition cycles from 1995 to 2018 with data through 30 September 2024. The 60/40 blend represents 60% S&P 500 Index and 40% Bloomberg US Aggregate Index. Long-term averages represented by the average five-year annualised rolling monthly returns from 1995.
With the Fed finally committing to rate cuts, we expect more and more investors to embrace being in the market. Of course, more demand should also help to support asset prices, and we anticipate return opportunities will continue to unfold.
Investors have better opportunities to reach their goals when invested
As Mike wrote last year, losses are painful both for us and for our clients, which is why it was a natural reaction for so many investors to seek the safety of cash after 2022. But as markets have recovered, the fresh opportunity to get invested is clear — and sitting on cash-like holdings should have less appeal.
We continue to believe that long-term investing in equity and fixed income markets is key to our clients achieving their goals. We remain optimistic about the market’s potential and will continue to pursue strong outcomes for our investors.
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Past results are not predictive of results in future periods. It is not possible to invest directly in an index, which is unmanaged. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.
Capital Group manages equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.