Is fixed income the play for 2023?

 

What are cheap, bonds or stocks? This a key question as we enter the new year because that will determine where many investors place their marginal dollars. There are several ways of measuring cheapness, and one is presented as z-scores for equities and bonds. Cheapness for asset classes is not easy to measure but the chart is consistent with the thinking of many at this time. By this measure stocks are still relatively expensive versus bonds that are cheap. The relative allocation suggests a tilt to bonds. This is not a bad baseline approach.

The actual returns of stocks and bonds plotted on a 2x2 table shows that 2022 was one the worst years on record for the combination of stocks and bonds. There are only three years which have both stocks and bonds negative, 1931, 1969, and 2022. 2022 was the worst year for bond performance from the data set which began in 1926.  

The big question is whether bonds will become a safe asset if inflation continues to fall, and whether equities jump higher once a recession starts. If inflation continues to decline and there is a further slowdown, bonds may be the superior investment. While higher stock and bond returns may be in store by the end of 2023, the path for returns is not clear given policy and economic trend paths.