Real Assets
The Attractive Opportunity in (Real Asset) Debt
Article
Dec 15, 2022
This year has been a historically difficult one for broad credit—in fact one of the worst in roughly the last three decades. Yet we see debt offering an attractive opportunity as we head into 2023 for three reasons.
The correlation between stocks and bonds is likely to revert to its recent negative norm. The correlation between stocks and bonds has generally been negative over the last few decades of low inflation. The two asset classes typically moved in opposite directions and offered diversification benefits. Yet that normal relationship has broken down during this anomalous year, with the correlation reaching its highest positive level since 1998. The prices of bonds and stocks have both gone down amid a record pace of Federal Reserve tightening, the COVID-fueled super-inflationary environment and recession fears.
Given the magnitude of the bond selloff, our view is that bonds appear close to pricing in peak inflation and the path of further Fed policy hikes during this tightening cycle. However, we believe the same can’t be said for stocks, in light of still elevated earnings multiples and a depressed equity risk premium. We believe there is likely volatility ahead.
As such, our expectation is that bonds may be in a better position to outperform in 2023 as economic growth and inflation slow and the Fed eventually cuts rates to avert or fight a recession, while equities may extend their declines amid weak corporate earnings, recessionary impacts and further multiple declines. We expect that the correlation between bonds and stocks will return to negative levels in 2023, with bonds again offering attractive portfolio risk-off protection.
Years with large broad-credit drawdowns, especially in high grade, are infrequent and are typically followed by positive performance. Past performance is certainly no guarantee of future performance. Yet the years during which broad credit experienced large drawdowns have typically been followed by years with positive performance, our research shows. Given the safer-haven status of debt vs. equities, attractive credit valuations following selloffs tend to attract capital, especially from insurance companies.
We have moved from TINA (“there is no alternative”) to DINA (“debt is now attractive”). Debt, at least for now, can finally compete for capital seeking income. Thanks to this year’s selloff in bonds amid rising rates, bonds—and credit exposures in particular—now offer an attractive income alternative to dividend-paying stocks. High-yield index yields, for instance, recently hit roughly two-year highs amid higher Treasury yields and wider credit spreads (bond prices and yields move in opposite directions). Stock dividend yields, in contrast, aren’t likely to be as attractive as in the past, given potentially heightened equity volatility ahead.
With the material rise in yields year to date, we believe debt has become increasingly attractive, providing greater insulation from potential future interest rate volatility. In our view, debt may offer a defensive profile vs. equity with limited downside potential and attractive value. Within debt, we believe a dedicated allocation to real asset debt can potentially enhance fixed-income portfolios in all market environments. Read more in the full Real Assets Monthly.
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This material is not, and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. All information is current as of the date of this material. Views and information expressed herein are subject to change at any time. Brookfield Public Securities Group LLC disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources however, Brookfield Public Securities Group LLC does not warrant its completeness or accuracy. This presentation is not intended to, and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which Brookfield Public Securities Group LLC is not licensed to conduct business, and/or an offer, solicitation, purchase or sale would be unavailable or unlawful. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.