Stu Morrow
Chief Investment Strategist, Morgan Stanley Wealth Management Canada
November 2023
Bringing Income Back Into Fixed Income: Tactically Positive on Fixed Income
Over the last two years, the interest rate environment has changed. We believe that the low interest rate regime that persisted since the end of the 2008 Financial Crisis has now ended, and we are in a period where interest rates are likely to stay higher for longer. This new era of interest rate normalization provides an opportunity for investors to revisit their fixed income and bond allocations.
Transcript
Title: Bringing Income Back into Fixed Income; Tactically Positive on Fixed Income
Welcome to Canadian Insights, where Morgan Stanley Wealth Management offers the Canadian perspective on global macroeconomic events, while as always, adhering to a long-term approach.
I’m your host, Stu Morrow, Chief Investment Strategist for Morgan Stanley Wealth Management Canada.
In this episode I am going to focus on our recent report titled “Bringing Income Back into Fixed Income; Tactically Positive on Fixed Income”.
For more details on our report, please visit our website at www.morganstanley.ca, or reach out to your Morgan Stanley Wealth Management Canada Financial Advisor with any questions.
Over the last two years, the interest rate environment has changed. We believe that the low interest rate regime that persisted since the end of the 2008 Financial Crisis has now ended, and we are in a period where interest rates are likely to stay higher for longer.
This new era of interest rate normalization provides an opportunity for investors to revisit their fixed income and bond allocations.
We are positive on bonds today for three reasons as detailed in our report.
First, as a result of higher interest rates today, in absolute-value terms, bonds offer higher yields per unit of interest rate risk, which provides a greater margin of safety for any further increase in interest rates.
Second, in relative-value terms, US Bonds appear attractive versus US Equities, a setup that has typically preceded relatively more favourable risk-adjusted returns.
And third, we have likely moved closer to the end of this rate hiking cycle than the beginning, which historically has been a positive for bond investors.
While we believe we are towards the end of this interest rate hiking cycle in both Canada and the US, there are potential risks to the inflation outlook, such as sticky wages and rising commodity prices, which might mean central banks are not completely done raising interest rates. If inflation were to remain above the central bank target, it may likely result in a delay to more accommodative monetary policy.
This would mean that capital appreciation opportunities for fixed income would become more limited, but even in that scenario we believe that investors would likely benefit from the absolute value presented in the form of higher yields.
We would note as well that current financial conditions are relatively tight and are likely to tighten further over the near-term, which we believe should limit the need for further interest rate hikes by central banks.
Finally, when it comes to fixed income investing, there are a few nuances that we detail in our report. These include the opportunity to invest in domestic and/or international bonds, public and private fixed income investing, as well as interest rate risk and credit risk considerations.
From a tactical asset allocation perspective, Morgan Stanley Wealth Management is overweight fixed income relative to our blended benchmarks.
Our positive view of fixed income is based on the belief that a “higher-for-longer” regime creates opportunities to achieve better risk-adjusted returns through the income stream, with the potential for capital gains if rates fade in 2024, according to Morgan Stanley Research forecasts.
Thank you for listening, please visit our website at www.morganstanley.ca for more information about our fixed income outlook.
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Index Definitions
S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.
Risk Considerations
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.
High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.
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Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.
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Disclosures
Morgan Stanley Wealth Management Canada Inc. (“MSWC”) is a wholly owned subsidiary company of Solium Capital ULC which in turn is a wholly owned subsidiary of Morgan Stanley, a publicly traded company listed on the New York Stock Exchange with its global headquarters located in New York City.
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