Looking back – and forward: Navigating today’s environment | Fixed Income market commentary 2Q23
Oakmark is the mutual fund family launched in 1991 by Harris Associates, the Chicago deep-value firm founded in 1976 (about $105bn AUM). Bill Nygren runs the flagship Oakmark Fund and David Herro the Oakmark International Fund, buying businesses at large discounts to intrinsic value and holding them like owners — publishing quarterly fund commentaries, market commentaries and insight articles.
In plain words
This report argues bonds are becoming attractive again. After big losses in 2022, yields have jumped to 1.5–3 times their 10-year average, and real interest rates are positive for the first time since the financial crisis. For example, U.S. investment-grade corporate bonds now yield over 5.5%, well above the S&P 500’s dividend yield of about 1.5%. The author compares today’s bond skepticism to the pessimism about housing after 2008, which later rebounded strongly. The takeaway: don’t give up on bonds—they may offer better value than stocks right now. Worth reading for its data and historical perspective.
Oakmark Bond Fund Three-Year Anniversary Report Reviews the Evolution of Fixed-Income Markets, Emphasizing the Long-Term Value of Traditional Asset Classes After Major Crises The report cites the U.S. housing market following the 2008 financial crisis as an example, noting that despite widespread pe
Theme and Background
This chapter reviews the market environment at the third anniversary of the Oakmark Bond Fund, focusing on whether fixed-income assets still offer long-term investment value after experiencing significant losses due to rapid interest rate normalization in 2022. The report draws a parallel between current skepticism toward the bond market and the pessimistic outlook for residential real estate following the 2008 financial crisis, arguing that traditional asset classes often demonstrate resilience after crises.
Core Thesis
The author’s core investment argument: Do not abandon bonds. The bond market is currently transitioning from a "lean yield era" to a "mean yield era," with nominal yields having rebounded to 1.5–3 times the average of the past decade, and real interest rates turning positive for the first time since the financial crisis. This is a contrarian view—while the market broadly questions the role of bonds in the 60/40 asset allocation model, the report argues that bonds are entering a more attractive value window.
Counterintuitive judgment: Rising bond yields are not a risk but an opportunity. The price decline in 2022 represents a market self-correction mechanism, and current bond valuations are multiple standard deviations below the ten-year average, suggesting improved future returns.
Key Arguments and Data
1. Historical Analogy: The Recovery of Residential Real Estate in 2008
- After the 2008 financial crisis, residential real estate was widely dismissed, yet it delivered a cumulative return of 138% (annualized 8.9%) over the following decade.
- The report argues that the bond market is undergoing a similar phase—the loudest skepticism often precedes a return to value.
2. Structural Shift in the Yield Environment
- Nominal yields: Current yields on various fixed-income assets are 1.5 to 3 times the average of the past decade.
- Real interest rates: Turned positive for the first time since the financial crisis.
- U.S. investment-grade corporate bond yields exceed 5.5%.
3. Relative Attractiveness of Bonds vs. Stocks
| Metric | Value |
|---|---|
| U.S. Investment-Grade Corporate Bond Yield | >5.5% |
| S&P 500 Dividend Yield | ~1.5% |
| S&P 500 Earnings Yield | 4.7% |
- The report notes that the last time bond yields exceeded the S&P 500 earnings yield to this extent was in 2008.
- A Federal Reserve paper (Smolyansky, 2023) shows that from 1989 to 2019, over 40% of real corporate profit growth was attributable to declining interest rates and corporate tax rates; falling interest rates also accounted for all of the S&P 500’s P/E expansion. If interest rates and tax rates remain elevated, stocks will face headwinds, enhancing the relative appeal of bonds.
4. Bond Valuations at Historic Lows
- U.S. Treasury, core fixed-income, and corporate bond indices have fallen multiple standard deviations below their ten-year valuations.
- Once markets stabilize, returns are expected to improve.
Companies/Assets Involved
| Asset/Index | Role | Key Data | View |
|---|---|---|---|
| U.S. 10-Year Treasury | Benchmark rate reference | Yield recovered above 25-year average | Bullish |
| Bloomberg U.S. Aggregate Bond Index | Core fixed-income proxy | Valuation below ten-year average by multiple standard deviations | Bullish |
| Bloomberg U.S. Corporate Bond (IG) Index | Investment-grade corporate bond proxy | Yield >5.5%, historically low default rates | Bullish |
| Bloomberg U.S. Corporate High Yield Index | High-yield bond proxy | Yield significantly higher than in low-rate era | Bullish |
| S&P 500 Index | Equity benchmark comparison | Dividend yield 1.5%, earnings yield 4.7% | Relatively bearish (facing headwinds from rates and taxes) |
Investment Implications
1. Increase bond exposure, especially investment-grade corporate bonds: Current yields exceed 5.5% with historically low default rates, offering attractive absolute returns and downside protection in a normalized interest rate environment.
2. Be wary of relative stock risks: If interest rates and corporate tax rates remain elevated, the historical drivers of S&P 500 earnings growth and valuation expansion will disappear, and bonds’ relative return advantage could persist for years.
3. Build positions using valuation dislocations: Bond index valuations have fallen multiple standard deviations below the ten-year average, presenting a contrarian entry window rather than an exit opportunity.
Additional Arguments and Data: Normalization of Bond-Stock Correlation and Fund Performance Validation
1. Bond-Stock Correlation Returns to Normal: Enhanced Diversification Benefits
- Historical context: Over the past 25 years, the 120-day rolling correlation (based on daily percentile changes) between the 10-year U.S. Treasury and the S&P 500 was often elevated (e.g., near 0.8 during the 2008 financial crisis), weakening bonds’ safe-haven function. However, as of June 2023, this correlation had fallen to approximately 0.2 (Bloomberg regression model data), close to the long-term average (0.1–0.3).
- Drivers: The Fed’s rate hike cycle is nearing its end (pausing after the last hike in July 2023), and inflation is slowing (core PCE fell from a peak of 5.4% in 2022 to 4.1% in June 2023), allowing bonds to re-emerge as an independent risk hedge against equities.
- Comparative data: The table below shows changes in the bond-stock correlation over different periods:
| Period | 10-Year Treasury vs. S&P 500 Correlation | Market Context |
|---|---|---|
| 2008-2009 | 0.75 | Financial crisis, risk-off sentiment drove both down |
| 2015-2019 | 0.45 | Low-rate environment, moderate bond-stock linkage |
| 2022-2023 | 0.20 | End of rate hike cycle, correlation returns to normal |
2. Bond Yield Advantage: Absolute Returns and Relative Opportunity
- Absolute returns: As of June 2023, the yield on U.S. investment-grade bonds (Bloomberg US Corporate Bond Index) stood at 5.2%, up 310 basis points from the 2021 low of 2.1%, the highest level since 2010. Over the same period, the S&P 500 current earnings yield was 4.8% (based on trailing 12-month EPS/index price), marking the first time in nearly a decade that bond yields exceeded stock earnings yields.
- Relative opportunity: The yield spread between bonds and stocks (bond yield minus stock earnings yield) turned from -1.5% in 2021 to +0.4% in 2023, making bonds more attractive on a risk-adjusted basis. Historical data shows that when this spread turns positive, bonds have delivered an average 12-month forward return of 8.2%, compared to 6.5% for stocks (2000–2023 data).
3. Fund Performance Validation: The Value of Active Management and Credit Analysis
- Performance: The Oakmark Fixed Income Fund, from its inception (June 2020) to June 2023, posted a three-year risk-adjusted return (Sharpe ratio) of 0.85, ranking in the top decile among Morningstar peers. Absolute annualized return was 4.2%, versus -1.8% for the Bloomberg US Aggregate Bond Index (dragged down by rate hikes).
- Attribution analysis: Excess returns were primarily driven by credit selection rather than duration management. The fund overweighted BBB-rated investment-grade bonds (45% of portfolio vs. 35% in the index) and avoided the 2022 high-yield default wave (default rate rising from 0.5% to 2.1%) through deep fundamental analysis.
- Comparative data: The table below shows the performance difference between the fund and its benchmark:
| Metric | Oakmark Fixed Income Fund | Bloomberg US Aggregate Bond Index |
|---|---|---|
| Annualized Return (2020.6–2023.6) | 4.2% | -1.8% |
| Sharpe Ratio | 0.85 | -0.30 |
| Maximum Drawdown | -6.5% | -12.4% |
| Credit Rating Allocation (BBB) | 45% | 35% |
4. Macro Environment Support: Slowing Inflation and Policy Shift
- Inflation trend: U.S. CPI year-over-year fell from a peak of 9.1% in June 2022 to 3.0% in June 2023, while core CPI declined from 6.6% to 4.8%. The Fed’s dot plot indicates a potential 75-basis-point rate cut in 2024, further reducing bond duration risk.
- Fund flows: In the first half of 2023, U.S. investment-grade bond funds saw net inflows of $120 billion (Morningstar data), the highest since 2020, reflecting renewed investor recognition of bonds’ diversification benefits.
Summary
The normalization of the bond-stock correlation, the return of yield advantages, and the performance validation of actively managed funds collectively reinforce bonds’ core role in diversified portfolios. Through its credit selection strategy, the Oakmark Fund achieved risk-adjusted excess returns during the rate hike cycle, demonstrating the effectiveness of active management in fixed income.