Investors will likely keep sending cash into bond funds in 2020, according to Ned Davis Research—and that could help fuel future market gains.
Bond markets posted strong performance in 2019. Investment-grade corporate bonds brought in 14%, Treasuries returned 7.6%, and high-yield bonds gained 12%, according to ICE BofAML Indices. Tax-exempt municipal bonds returned 7.4%.
Investors sent a steady flood of cash into bond funds in 2019. While they were likely responding to strong fixed-income performance, the influx of cash started a virtuous cycle that drove further bond-market gains. Taxable-bond funds brought in a net $518 billion of investor cash for the year ended Dec. 25, according to Refinitiv Lipper data, while municipal-bond funds attracted $65 billion of net inflows.
Demand for bond funds will be even more important for the market’s performance in 2020, Ned Davis strategist Joe Kalish writes in a Tuesday note.
Other factors—policy easing from global central banks and a mild slowdown in economic growth—also helped drive this year’s bond-market gains. Remember, investors didn’t expect three Federal Reserve rate cuts at the very start of 2019, even as bonds rallied on signs of a slowdown in economic growth and low inflation.
But all of those trends are now fully reflected in markets. The slowdown in growth isn’t looking as severe as some investors feared. Strategists predict that the Fed will hold interest rates steady this coming year and that the central bank won’t want to risk a policy mistake ahead of the 2020 U.S. presidential election.
That leaves investor demand as the last remaining catalyst that could trigger more bond-market gains.
Kalish says demographics should keep money coming into bond funds, as baby boomers age and put more cash into lower-risk bond markets, which financial advisers have traditionally recommended.
What’s more, foreign investors may want more U.S. bonds now that the Fed’s rate cuts have reduced their costs of hedging currency exposure, he says. Specifically, European investors have plenty of reason to look abroad for yield now that the European Central Bank has restarted its bond-buying stimulus efforts.
Ned Davis expects bond yields to stay steady or move slightly higher in 2020. Prices fall when yields rise, so that call would imply mild paper losses for investors.
Even so, the firm is recommending that investors keep a higher-than-normal allocation to bonds into 2020, along with lower-than-normal allocations for stocks and cash.
Write to Alexandra Scaggs at [email protected]