How investors are gearing up for the end of Fed rate hikes, according to MFS survey

Investors gearing up for the Federal Reserve’s rate-hiking campaign to draw to a close have been migrating into beaten-up bonds and “undervalued” stocks in recent months.

Five months ago, roughly 52% of respondents in the fixed-income market said they were raising the duration in their bond holdings, according to a MFS survey conducted from May 31 to June 5, but released on Wednesday.

Almost one in three said they planned to boost allocations to U.S. credit in 2024, while about a quarter said they expected to increase in emerging-market debt.

“Clearly, investors have been de-risking over the past six to 12 months,” Jon Barry, managing director, MFS Investment Solutions Group, told MarketWatch in a follow-up call.

Results of the survey, now in its fourth year, also mark a notable shift in sentiment after an era of low rates, with fixed income finally viewed as “fairly valued,” something “it hasn’t been for a long time.”

Investing in longer-duration bonds hasn’t been for the faint of heart, with values recently declining by the most in nearly two decades in the wake of some 18 months of Fed interest-rate hikes.

See: Why a derailed $11 trillion corporate bond market looks ripe for a comeback as U.S. inflation slows

In the latest bout of volatility, the 10-year
and 30-year Treasury yields
surged to about 5% in October, the highest in 16 years. But with their swift retreat to 4.5% and 4.7% yields, several major U.S. bond indexes this week were lifted back into the green for the year, from a total return perspective.

The closely watched Bloomberg U.S. Aggregate index, which tracks investment-grade U.S. bonds, was on pace for a roughly 0.4% total return on the year through Wednesday, according to FactSet.

The related $92.5 billion iShares Core U.S. Aggregate Bond ETF
was on track for a 0.7% total return in 2023, according to FactSet.

The latest retreat in bond yields has been pegged to growing optimism around fading inflation pressures and about the U.S. economy potentially avoiding a recession, even if the Fed only modestly cuts rates next year.

“On the equity side going forward, they are seeing opportunities in stocks that got a little more beaten down in the past few years,” Barry said.

The S&P 500 index
up 17.5% on the year as of Wednesday, the Nasdaq Composite Index
up 35% and the Dow Jones Industrial Average
up 5.7%, according to FactSet.

Read: S&P 500 close to exiting correction territory as JPMorgan warns risk-reward in stocks appears ‘unattractive’

Even with the recent rally, many bond indexes still remain deeply negative when looking at multiyear returns, with the Bloomberg US Treasury (20+Y) index on pace for a negative 39% 3-year total return, according to FactSet data.

The related $42.7 billion iShares 20+ Year Treasury Bond ETF
was down about 7.3% from a return perspective, on the year.

Back in equities, about 60% of the MFS survey respondents said they expect U.S. small-
and mid-cap stocks to outperform large-cap stocks in the next one to three years.

Roughly 21% said they planned to reduce their large-cap and growth-stock exposure in the next 12 months.

The MFS survey included 112 individuals representing a range of firms that had from under $1 billion to over $1 trillion in assets under management.

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