(Bloomberg) -- Stocks and bonds have been moving apart, a sign investors can bump up allocations to risky assets, according to Pacific Investment Management Co.
As price pressures cool and the growth of the US economy slows, the inverse relationship between equities and bonds has revived, according to Pimco, one of the world’s biggest bond managers.
“The stock/bond correlation tends to turn lower and then negative as inflation and GDP growth moderate, as is the case in the US and many other major economies today,” Erin Browne and Emmanuel Sharef, Pimco portfolio managers for asset allocation, wrote in a report. Investors “can increase and broaden their allocation to risk assets, seeking potentially higher returns with the potential for adding little to no additional volatility within the overall portfolio.”
The Bloomberg US Aggregate Index has gained 1.6% this year through Tuesday, while a stocks rally has rocketed the S&P 500 Index up 24% so far in 2024.
“Equities and bonds can complement each other in portfolio construction, and both are likely to benefit in our baseline economic outlook for a soft landing amid continued central bank rate cuts,” they added.
The Federal Reserve kicked off its cutting cycle with a half-point reduction in September and then lowered rates by another quarter percentage point earlier this month. Swaps traders are assigning about a 50-50 chance that the US central bank will cut rates again in December as policymakers try to navigate slowing growth without tipping the economy into a recession.
Generally, in a soft landing scenario US equities gain into and through the first rate cut but then taper off three months after in the median case, a Pimco analysis of Fed rate-cutting cycles through 1960 showed. Bond returns, in various economic backdrops, were positive when the Fed was easing, according to their analysis.
For its multi-asset portfolios, the Newport Beach, California-headquartered firm favors a slight overweight to the US for stocks and on the debt side has a bias for high-quality core bonds, which typically includes investment-grade debt.
In equities, investors should focus on US companies with earnings that don’t rely heavily on imports given President-elect Donald Trump’s plans to raise tariffs, they said. Trump has proposed raising tariffs to 60% on goods imported from China and to 20% on items from other countries. The asset manager views firms that are set to benefit from the new administration’s planned tax cuts and looser regulation as good portfolio adds.
Read the QuickTake: Why Trump’s Plan to Escalate Tariffs Has Many Haters
Investors can increase their allocations to risk assets in a bid for higher returns “with the potential for adding little to no additional volatility within the overall portfolio,” Browne and Sharef wrote.
The surge in yields ahead of, and following, Trump’s election win as well as Republicans gaining control of both Houses of Congress has bumped rates up to an attractive range, according to the Pimco team.
“An allocation to inflation-linked bonds or other real assets could help hedge against the potential risks of increasing inflationary pressures arising from fiscal policy or tariffs,” Browne and Sharef said.
The benchmark 10-year Treasury yield hovered at about 4.4% on Wednesday, up over three-quarters of a percentage point from its low this year of 3.6% reached in mid-September. Real rates, as gauged by the yield on US 10-year inflation-protected securities, or TIPS, have jumped to just over 2% from about 1.5% in early October.
“A lower or negative stock/bond correlation allows for complementary and more diversified cross-asset positioning, especially for those with access to leverage,” they added.
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