Did you miss the rally in stocks and bonds?

A little over a year ago, our CEO, Mike Gitlin, wrote about the significance of the end of the Federal Reserve’s rate-hiking campaign — and the opportunity it presented to investors. The article looked to history for hints of what it might mean for stock and bond markets, noting that as the central bank pivoted, returns were strong. We suspected that moment would also be a turning point for markets, which had experienced a very rough 2022. Those who acted boldly and got invested at that time likely feel good about having moved some cash holdings into stock and bond investments.

A 60% equities/40% fixed income portfolio would have gained more than 26% over the twelve months ending September 30, 2024, using the S&P 500 Index for equities and Bloomberg U.S. Aggregate Index for fixed income as proxies. Each market separately also far outpaced the 5% or so a cash-like investment in a certificate of deposit (CD), as represented by Bankrate.com’s U.S. 1-year High Yield Savings Rate, might have provided. The lesson learned is clear: Investing is about taking a long-term perspective in pursuit of long-term goals. For those who may have missed that upside, has the opportunity passed? We don’t think so.

The Fed is just getting started, and bonds should benefit

The U.S. central bank has made its path forward crystal clear: It is in rate-cutting mode. The Fed surprised many investors in September with an aggressive 50-basis-point cut in its policy rate, rather than a more modest 25 basis point easing. It has projected another 50 basis points of cuts this year and an additional 100 in 2025. The market expectation is slightly lower, predicting roughly 125 basis points of cuts over the next five quarters, as of October 28, 2024. Many other major developed market central banks have also begun cutting as inflation pressures wane.

With bond yields lower than a year ago, those who weren’t invested may worry that they’ve missed out. Fortunately for investors, recent increases in rates provide another entry point, and history has shown that potential upside for bond investors persists following the start of Fed cuts. To be sure, past performance is not necessarily predictive of future performance. But historically, while bond yields declined in the period before the first cut, they continued to fall after that key pivot as well.

Declining yields are a key tailwind for fixed income returns, since bond prices rise when yields fall. That’s a major reason why bond returns were so strong over the past year. The 2- and 10-year U.S. Treasury yields were down 140 and 79 basis points over the 12 months ending in September. Markets began to anticipate cuts, yields moved lower across the Treasury curve, and bond returns benefited. As the Fed continues cutting, history suggests that yields could continue to drift down. Of course, if the U.S. economy hits an unexpected soft patch, the Fed could cut even more aggressively to combat rising unemployment. Importantly, rising bond prices are only one component of total returns in fixed income — and current market yields offer investors compelling income opportunity across a range of fixed income investments.

Here, investors could consider a high-quality, true core bond fund with a moderate duration (a measure of interest rate exposure). Such a position, whether taxable or tax-exempt, would seek to take advantage of attractive current yields and the potential for capital appreciation as yields fall, while also providing diversification from equities if faced with unanticipated volatility. There are multiple paths to strong fixed income returns. If the Fed cuts more gradually from here, yields across corporate, securitized and other sectors could remain attractive relative to levels over the past decade. And if a soft landing is achieved, credit should prosper.

Some stocks have gotten expensive, but we still see opportunities

We are seeing some mixed signals in markets, but at this point it looks like the Fed has managed to usher in lower inflation without jarring the economy into recession. Its cuts may help to reduce discount rates and provide some support for today’s high equity valuations. However, our portfolio managers are being selective and relying on our analysts’ fundamental research on sectors and companies.

For example, some of the largest 50 or so companies continue to dominate indices. Yet recent valuations and projected earnings indicate that growth may slow for some companies, specifically for the Magnificent Seven (Apple, Microsoft, Amazon, NVIDIA, Alphabet, Tesla, Meta).

Given this broadening of the market, a few areas, such as aerospace equipment and biotechnology, may be of particular interest to investors. Travel has recovered to pre-pandemic levels, and a nearly decade-long backlog of passenger aircraft remains to meet the growing demand for air travel. For biotechnology, we are finding select companies developing gene therapies and other innovative treatments to address previously difficult to treat conditions.