The recent performance of Treasury bonds has been nothing short of a disaster. However, amidst this turmoil, one major European investment bank sees a glimmer of hope.
According to Mark Haefele, the chief investment officer at UBS Global Wealth Management, there is potential for a "soft-ish" landing for the U.S. economy. This, combined with his prediction of Federal Reserve interest-rate cuts in the near future, could overshadow concerns about the U.S. budget deficit and trigger a powerful rebound in Treasurys.
Haefele pointed out that between May and October of this year, the yield on the 10-year Treasury has risen from 3.3% to 4.8%. A significant portion of this increase occurred since September. Despite these numbers, UBS does not anticipate a severe U.S. recession in the coming months. Haefele believes that a gentle economic slowdown could actually bolster the position of Treasurys. Consequently, investors who choose to buy bonds now stand to benefit from higher yields and strong total returns if the U.S. economy does succumb to the Fed's interest-rate hikes.
In fact, Haefele estimates that if the U.S. economy enters a recession in the upcoming months, 10-year Treasurys could yield a total return of 19% by June.
In contrast to their relatively positive outlook for bonds, Haefele and his team appear to be less enthusiastic about stocks. This sentiment aligns with comments made by another team of UBS strategists last week. David Lefkowitz, head of U.S. equities at UBS, adjusted his target for the S&P 500 to reflect a slightly more pessimistic outlook for U.S. stocks. He now projects that the index will not reach 4,700 until December 2024, rather than June. This places UBS in the middle of the pack in terms of S&P 500 targets.
As the earnings season commences, Lefkowitz anticipates that U.S. corporate earnings will demonstrate year-over-year growth during the third quarter, following three consecutive quarters of contraction. This view is increasingly shared among Wall Street analysts. For 2024, Lefkowitz expects earnings to grow by 9%. Nevertheless, expectations of higher and more prolonged Treasury yields are likely to dampen equity returns.
Lefkowitz summarized UBS's revised price targets as 4,500 for June 2024 and 4,700 for December 2024. The delayed timeline for their 4,700 target is primarily a result of the recent rapid surge in interest rates and fixed income colleagues' expectation of a longer duration of high rates, Lefkowitz explained.
The Outlook for Bonds and Equities
Despite differing opinions, UBS remains bullish on bonds and neutral on global equities. They continue to favor emerging market stocks as an asset class.
Not all investors are in agreement with UBS. Leon Cooperman, Chairman and CEO of Omega Advisors, has expressed his reluctance to invest in long bonds until yields exceed 5%. Similarly, Bill Ackman, Founder of Pershing Square Capital, has bet against 30-year Treasurys, anticipating yields of 5.5% or higher.
However, there are many investors who see value in the current market conditions. In September alone, over $920 million was poured into the iShares 20+ Year Treasury Bond ETF (TLT), making it one of the most sought-after Treasury bond ETFs this year.
A Challenging Bear Market
The Treasury bond market is currently experiencing one of the toughest bear markets in history. According to Bank of America strategists, Treasury prices are projected to decline for the third consecutive year in 2023, a scenario that has never occurred before.
Bond-market strategists attribute this selloff to several factors. These include the Federal Reserve's aggressive interest-rate hikes, persistent inflation, and investors demanding higher term premiums for longer-dated bonds due to the uncertain outlook for monetary policy. However, UBS's team dismisses the idea that stubborn inflation is solely responsible for the recent rise in yields.
On Monday, treasury yields were on the rise. The yield on the 10-year bond increased by 6.2 basis points to 3.875%, while the yield on the 30-year bond rose by 8.5 basis points to 4.125%. It's important to note that as bond yields rise, bond prices fall.