Edinburgh investment giant Abrdn is “on the lookout for the right signs” to increase its exposure to bonds amid the soaring inflation that is “upending traditional methods of diversification and multi-asset investing.”
That’s according to Carl Jones, Abrdn’s senior investment director, global active allocation.
While conceding that “the road towards portfolios being fully loaded up again with bonds is likely to be a bumpy one” Jones said nonetheless that Abrdn expects to see “a resurrection of the humble bond over the next 12 months.”
Jones said Abrdn is “fuelling up and preparing as best we can for the unknown journey ahead.”
Abrdn manages and administers about £540 billion of assets.
In a commentary entitled “Is now the right time to buy back into bonds?” Jones wrote: “Inflation is back. It’s been four decades since investors have had to take soaring inflation into account and it is upending traditional methods of diversification and multi-asset investing.
“The long-held, favourite portfolio allocation of 60/40 equities to bonds has been found lacking; with both bonds and equities losing value at the same time, investors can no longer rely on bonds to provide diversity against equities.
“But could we see a resurrection of the humble bond over the next 12 months? We believe so and we are on the lookout for the right signs to increase exposure, while being mindful that timing could be everything.
“The road towards portfolios being fully loaded up again with bonds is likely to be a bumpy one. In fact, there is so little clarity on the eventual macro outcome that you could compare this journey to driving at night, in a storm, with no headlights.
“The situation is incredibly volatile as factors including geopolitics, monetary policy and supply-chain disruptions could turn on a dime, leading to the overshooting (or undershooting) of targets.
“So, what indicators are we looking for along the way?
“Well, history does not repeat but it often rhymes and we can look to the past to guide us.
“When the Federal Reserve has raised interest rates previously, we’ve tried to establish at what point bond yields stabilise during rate-hiking cycles.
“Looking at the evidence right back to the 1980s, it suggests that you have to get a fair way through the hiking cycle before bond yields peak.
“How long do we think this rate-rising cycle will go on for?
“We estimate a hiking cycle that is not too different from what is currently priced into markets, but the distribution around this can be quite wide.
“We could be looking to a point in late summer, after a few more 50bp rate hikes, before we feel comfortable that we are entering the final stages of the Fed’s hiking cycle.
“It could be sooner, or take longer; we’ll have to wait and see.
“We are also looking at a number of growth and inflation indicators to give us comfort that growth is slowing meaningfully and inflationary pressures have peaked and are rolling over.
“On the growth front, we are monitoring the Institute of Supply Managers (ISM) index and the Citigroup Economics Surprise Index (CESI) closely.
“On inflation, we are hoping to see core inflation (rather than headline) drop to more typical levels, as this may signal an end to Fed hiking and more certainty that inflation is peaking.
“Right now, inflation is a real challenge. We’ve not seen it at these levels since the 1970s and ’80s, and we want signs that a wage-price spiral is not on the cards.
“While we also have target levels for bonds yields in mind before we start building holdings again, we prefer to combine these with the fundamental waymarks highlighted above, rather than solely rely on yield levels.
“Is there a danger of interest rates going very high? At this stage, possibly. But due to the amount of debt in the economy, the level that rates can rise to is likely to be much lower than in the past.
“While the level of yields is important, the rate of change in yields is also important.
“If consumers, corporations and governments are expecting to repay debt at one rate and it suddenly changes, that makes a big difference to every kind of decision from spending to investment.
“For now, we’re checking the tyres, fuelling up and preparing as best we can for the unknown journey ahead.”