In brief
- Past rate-cutting cycles have generally supported positive performance in equities and consistent positive returns in bonds, suggesting a favourable environment for multi-asset portfolios, especially during economic soft landings.
- Despite recent strong performance of multi-asset income portfolios, yields across many asset classes remain near multi-year highs, offering attractive opportunities for investors to lock in attractive yields and benefit from potential future returns.
- In the past, stocks and bonds tended to be negatively correlated when inflation drops below 3%. This marks a significant shift for multi-asset investors and is expected to strengthen diversification in portfolios.
- Historical data indicates that multi-asset income strategies have outperformed cash in both low and higher rate environments, making them a more attractive option for long-term investors looking to grow capital and earn substantial income.
In September 2024, the Federal Reserve (the Fed) cut interest rates for the first time in four years. This highly anticipated move marked a significant event in the global economic landscape, as the Fed joined other major central banks in an accelerating rate-cutting cycle. Here, we answer the main questions for multi-asset income investors about the investment outlook and its implications for income-oriented portfolios.
1. What can multi-asset investors learn from previous rate-cutting cycles?
By examining past cycles, we can gain valuable insights into how different asset classes might perform during a rate-cutting cycle (see Exhibit 1).
In equities, we find that four of the last six Fed rate-cutting cycles have resulted in positive performance, although the impact of Fed cuts is not uniform and ultimately depends on the state of the economy and starting valuations. Equity performance was particularly strong through the soft landing of 1995.
For bonds, historical data shows that U.S. Treasuries have consistently delivered positive returns in each easing cycle over the past 40 years. Despite recent gains in bond markets, investors expect more cuts this year and into 2025, which could further support returns.
These lessons from previous cutting cycles point to a supportive environment for multi-asset portfolios, which would be particularly pronounced in the scenario of an economic soft landing.
2. How have multi-asset income strategies performed in the current rate cycle and what can investors now expect?
The first half of this interest rate cycle was challenging for markets. Inflation dynamics in 2022, which saw the highest inflation since 1981, almost exclusively defined market returns, leading to the worst year ever for bond performance and the first time in nearly 50 years that both stocks and bonds fell in the same calendar year. However, since 2023, income investors have enjoyed a healthy performance rebound, which has accelerated into 2024 and looks set to continue as we enter the second half of this rate cycle, where interest rates start to drop.
As of today, yields across many asset classes are still close to multi-year highs. In fact, investors haven’t seen a convergence of yields on equities, bonds, and other asset classes at levels of 4% or more in 20 years. This market backdrop continues to offer compelling opportunities for income investors and multi-asset strategies, such as JPMorgan Investment Funds – Global Income Fund. The fund’s gross portfolio yield remains close to its highest level in 10 years (Exhibit 3).
This current starting point offers an opportunity for investors to lock in high yields, given the starting yield of an income portfolio tends to be a good indicator of future returns. Historically, returns have been particularly strong at yield levels starting from 5% or higher (see Exhibit 4).
3. How does the cutting cycle impact correlations and how can multi-asset investors benefit from improving diversification?
The Fed's decision to cut U.S. interest rates and start a cutting cycle marks a significant shift in the economic landscape. Previously, the Fed was primarily focused on bringing down inflation. However, with inflationary pressures now more contained, the Fed has shifted its emphasis to its dual mandate, which includes maintaining a strong labour market alongside price stability.
This shift has important implications for multi-asset portfolios when assessing the relationship between inflation, stocks, and bonds. Data since 1962 indicates that when inflation is around 3% or below, stocks and bonds tend to be negatively correlated. This relationship is crucial for multi-asset investors and contrasts sharply with the environment in 2022 and most of 2023, where high inflation made both stocks and bonds less attractive, complicating traditional risk management in portfolios (Exhibit 5).
The current market backdrop underscores the strategic importance of incorporating bonds into portfolios, not only as a source of income but also as an instrument to provide stability and diversification if needed. Should yields fall further, investors stand to benefit from additional price gains on bonds. Should yields rise, the current yield on offer would buffer total returns by offsetting price volatility. And should yields remain unchanged, the current high carry on the portfolio offers a cushion that allows investors to be patient while they earn substantial income. Taken together, the outlook highlights the improved asymmetry income investors stand to benefit from today.
4. Why should investors consider locking in attractive income while they still can?
While the pace of future interest rate cuts ultimately depends on incoming economic data, absent any major economic shock, interest rates will likely settle at a higher level compared to the last decade. That said, still elevated yields and low prices across fixed income markets represent an opportunity for income investors as we move deeper into the rate cutting cycle.
Following the aggressive repricing of bond markets in 2022, certain markets still offer bond prices at multi-year lows. The situations means there is still plenty of return potential, and investors can benefit from an additional yield component besides the coupon income.
The “pull to par” effect is an important concept for bond investors and refers to the tendency of a bond's price to move closer to its par value as it approaches its maturity date. Average prices at 94% of par value in our US high yield bonds and 96% in our European high yield bonds mean there is still significant return potential beyond the coupons on offer.
To illustrate this effect, Exhibit 8 shows how the convergence of bond prices to 100 (percent of par value) as they near maturity, generates “pull to par” returns for investors. The bond issued by Volvo offered a coupon of 2% while investors earned a 5.1% total return in the past 12 months due to the price converging towards maturity.
5. Why does the current set-up in equity markets represent an attractive environment for income seekers?
Recent macro data further supports the thesis of an extended economic cycle and trend-like growth. This in turn is helping to drive the long-anticipated broadening out of US corporate earnings, which that is finally underway. Yet valuation dispersion in the stock market remains very high. As earnings growth becomes more evenly distributed across sectors we could see a further rotation in markets and a reduction in the discounts of some less-loved equity segments, such as like dividend-oriented stocks. Meanwhile, as their business models mature, mega cap tech companies are beginning to initiate dividends and focus on cash generation, expanding the investment universe for income seekers. This backdrop calls for a more balanced approach to equity investing in the coming quarters, further supporting the outlook for income-oriented investors.
6. Why should investors favour a multi-asset approach instead of cash in a rate cutting cycle?
With interest rates coming off peak levels, investors should consider using the rate-cutting cycle to their advantage. One option is to extend from cash into diversified multi-asset strategies.
Given recent market volatility and elevated yields on cash, many investors have preferred cash as a safe haven asset or even a source of income in their portfolios. But previous rate-cutting cycles clearly show that cash is likely to underperform as yields fall. Even if interest rates settle in a higher range than the last cycle, today’s elevated cash yields won’t last forever, and investors need to be mindful about reinvestment risks.
We believe better opportunities exist, especially for long-term investors looking to grow their capital and earn an attractive stream of income. Looking at the years from 2008 onwards, multi-asset income strategies were particularly relevant to investors amid the extended low-rate environment. A representative income portfolio, providing a similar return pattern to the JPMorgan Investment Funds – Global Income Fund, outperformed cash 74% of the time over a one-year rolling period through the low-rate environment that followed the Global Financial Crisis.
But what about in a more normal rate environment, such as today’s? From 1991 to 2007 the same type of multi-asset income portfolio produced similarly strong results in a higher rate environment, outperforming cash 77% of the time and delivering a higher average one-year rolling return.
Translating these historical patterns to today suggests that the outlook for a multi-asset income strategy is positive and may in fact be improving, supported by higher bond yields and better diversification potential from duration. In this environment, a multi-asset income portfolio has the opportunity to achieve an attractive income stream with less risk and well above cash.
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