Asset allocation: The conundrum of 2014

Global Perspectives Blog
  • When economic growth levels off, the headwinds for bonds subside, which fits the patterns of 2014 so far.
  • With bond yields at current levels, the attractiveness of interest rate risk from a valuation standpoint is meager.
  • Should the economic data reaccelerate, we would expect equities to perform well and rate sensitive bonds to struggle.

In 2013, both the S&P 500 Index and the yield on 10-year Treasury bonds finished the year at their highest levels of the calendar year. So ended a year when equity markets dominated the return landscape, while bonds and numerous other assets struggled. The environment apparently changed, though, with the turning of the calendar to 2014. In the New Year, bonds have performed quite well, with yields on 10-year Treasuries, as an example, falling from 3.03% to 2.67% so far this year. Stocks meanwhile, have been volatile, yet stand close to unchanged on a year to date basis.


Source: DataStream, February 2014

There are two good reasons for bond yields to have fallen this year. First, having closed 2013 above 3%, bond yields had reached a level where interest rate risk was no longer over-priced. With valuation back to fair value, at least in the short run, bonds had become a relevant choice for portfolio diversification once again. Second, the economic data have been markedly weaker so far in 2014 than most forecasters expected. Our research on asset class sensitivities to economic activity suggests that in an economy that is both growing and accelerating, like we saw last year, equities perform well while interest rate sensitive bonds, like Treasuries, struggle. When economic growth levels off, the headwinds for bonds subside, which fits the patterns of 2014 so far quite well.

The last two months notwithstanding, we think that investors should hold off on declaring the environment of equity hegemony (see Q1 Investment Strategy Outlook for discussion on equity hegemony) to be finished. Stocks, as measured by the S&P 500, have recently eclipsed their 2013 highs and as of this writing stand in record territory. Bond yields, meanwhile, remain far below their 2013 closing levels. This inconsistency bears watching in the weeks ahead. With bond yields this low, the attractiveness of interest rate risk from a valuation standpoint is once again meager. Should the economic data reaccelerate, we think the recent equity breakout would be validated, and the friendlier environment for bond yields that has defined 2014 so far would be but a memory.


Source: DataStream, February 2014

This week, several key U.S. economic releases will shed some light on these issues. Personal income, purchasing managers surveys and the monthly payroll report, all bellwether releases, are being reported during the week. Should these data (or subsequent statistics, in fact) portray reacceleration, we would expect further equity market strength but also bond market weakness. Markets, we think, would revert to their 2013 patterns. This remains our central case for the months ahead. Stubbornly low Treasury yields going forward, therefore, would signal that we should rethink our central case. As always, we continue to closely monitor global markets and adjust our investment strategy accordingly.




Tagged with: Asset Allocation, Equities, Fixed Income, Investing

About the Contributor

The views expressed in this material are the views of the author through the date of publication and are subject to change without notice at any time based upon market and other factors. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. This information may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those discussed. There is no guarantee that investment objectives will be achieved or that any particular investment will be profitable. Past performance does not guarantee future results. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. Please see our social media guidelines.

About Us

Backed by more than 100 years of experience, Columbia Management is one of the nation’s largest asset managers. At the heart of our success and, most importantly, that of our investors, are highly talented industry professionals, brought together by a unique way of working. At Columbia Management, reaching our performance goals matters, and how we reach them matters just as much.