Bond rates are expected to increase over the next six to twelve months due to upward pressure from sticky inflation and worsening fiscal outlooks. This explains why MRB Partners, independent investment strategists, advise keeping multi-asset portfolios with an overweight exposure to cash.
According to a report released by the company, one noteworthy aspect of the past ten years is that, as indicated by the difference between the 10-year notes BX:TMUBMUSD10Y and the 3-month bills BX:TMUBMUSD03M, developed market government bonds have not been able to surpass cash returns.
“Investors are still too complacent on the long-run [developed market] inflation outlook, especially in the market-leading U.S.” according to MRB research.
In reversing the March shift to underweight, the MRB research team highlights the global economy’s resiliency by switching their tactical equity weighting to neutral. However, because rising bond yields lower valuations due to higher discount rates that diminish the current value of future cash flows, they predict limited upside for equities.
Even while MRB views the current trade issues “as an irritant rather than a major risk to U.S. or global economic growth,” they explicitly state that “we are not sanguine about the capital markets outlook.” The U.S. economy is in a “late cycle,” American stocks are “expensive in aggregate,” and rising bond yields are a big worry.
With the U.S. index SPX up 2% and the iShares MSCI ACWI ex-U.S. ETF ACWX rising 16%, the S&P 500 has underperformed the majority of foreign stock markets this year.
The issue facing fixed-income investors is already well-established, and according to MRB, the deteriorating fiscal situation, accommodative monetary policy, and upside inflation risks may eventually push U.S. bond yields BX:TMUBMUSD30Y beyond 5%.
Although it’s unknown when this may happen, the company claims that if it does, there will be negative ripple effects and markets will become considerably more concerned about the sustainability of global economic growth.
Notwithstanding the resilience of American consumers and the tenacity of American growth, this worry is what justifies a neutral stance toward stocks. MRB recommends underweight duration (longer-dated instruments) for bond portfolios and finds superior value in local currency emerging market debt and corporate credit.
In response to the uncertainties surrounding the tariffs debate, MRB states that “neither hard nor soft data will provide reliable signals about near-term economic performance,” primarily because large deals and announcements are unpredictable. However, as long as bond markets continue to act favorably, global stocks will have a favorable tilt since U.S. financial conditions are still easy.
According to MRB, this type of trading environment means that gold (GC00) will continue to have tailwinds, and the team predicts that as investors diversify away from U.S. assets, the dollar DXY will continue to depreciate. This explains the “mild U.S. underweight” in international stock portfolios, which favors emerging markets (EEM), Japan (EWJ), and the eurozone.
