Bonds Offer Income as Rates and Equities Churn
Weekly Market Update
Takeaways
High-quality, low-duration fixed income remains attractive in this environment. Elevated yields provide a strong starting point, but macro conditions argue for patience on duration and discipline on credit.
Global earnings trends remain supportive for the market backdrop. Secular winners continue to impress with strong earnings growth, while above-trend growth in cyclical regions and industries provides a near-term foundation for the rotational market.
This Week in Charts
Looking Closer
High quality yields are on the upper end of their 15-year historical range. This presents an attractive entry point for a fixed income portfolio given the strong relationship between starting yield and forward three-year total returns.
Market and Data Recap
High-quality, low-duration fixed income remains attractive in today's environment
Today's fixed income environment challenges investors to balance attractive absolute yields with headwinds from higher-biased rates and limited portfolio ballast to equity risk. We believe investors should consider a high-quality, low-duration portfolio until the macro environment shifts.
Recent economic data trends align with our start-of-year outlook: easier monetary and fiscal policy, resilient corporate profits, and strong balance sheets support cyclically strong nominal growth. We expect the Fed to remain on hold for the first half of this year, which should keep front-end yields at an elevated level as investors price out near-term rate cuts.
Meanwhile, recently strong economic data as seen in the Citi U.S. Economic Surprise Index, along with secular factors around fiscal balances and foreign entities diversifying U.S. assets, has created a steepening bias in the curve as backend rates adjust higher. We remain underweight duration as longer-end rates remain biased higher within their recent range. At the lower end of Treasuries' recent trading range of 3.5-4.5%, bonds have shown limited hedging potential during equity declines. The equity-rate correlation between equities and rates typically turns negative only when the 10-year yield moves above 4.5%. At that level, we would consider adding duration given more attractive yields and improved portfolio construction. Globally, the higher rate path appears even more pronounced for non-U.S. developed markets where we maintain our largest duration underweight. Pockets of emerging markets sovereign bonds offer attractive risk-adjusted yield until developed markets rates inflect.
Moving down in credit quality presents challenges as well given historically tight spreads. To note, the difference between High Yield (below investment grade rated) and Investment Grade corporate bond spreads (difference between the bond yield and Treasury yield at given maturity) is also near all-time tights. Said another way, investors are not being properly compensated for taking on excessive credit risk. While we do not believe the macro backdrop supports an increase in default risk and therefore significant credit underperformance, we believe the rich valuations in credit present limited total return upside in High Yield bonds. For more total return upside in a portfolio, we prefer adding cyclical equities in this macro environment given the high directional correlation of high yield bonds and equities.
Overall, high-quality bond indices remain at the upper end of their 15-year yield percentiles. This presents an attractive starting point for building a fixed income portfolio given the tight relationship (R2) of your starting yield and forward three-year total return (Figure 1). While staying up-in-quality reduces unnecessary credit risk without proper compensation, focusing on shorter-duration products also limits return downside if rates backup further and bond prices fall.
Bottom Line: We remain underweight duration because the global macro backdrop may limit meaningful declines in rates. Treasuries currently provide reduced capacity for hedging equity risk. Extra yield compensation for moving down in credit quality is also at all-time-lows, supporting our up-in-quality bias. We prefer to focus on high-quality, low-duration fixed income in today’s environment.
Broadening earnings growth continues to underpin market strength
Ahead of the 4Q25 reporting season, consensus expected S&P 500 earnings to rise about 7% year-over-year. With nearly 80% of market cap reported, growth is tracking closer to 12%, marking the fifth straight quarter of double-digit, year-over-year gains. Technology remains the primary driver, delivering roughly 26% earnings growth. The rest of the index is growing closer to 6%. While less impressive, this is still above-trend for the cohort. Despite ongoing concerns around U.S. concentration, the durability of Tech leadership, and capex pressures, the fundamental earnings backdrop remains robust from both secular and cyclical industries. We see this as evidence of holding on to the former despite recent volatility and capturing upside in the latter with complementary exposure.
Earnings revisions have also broadened meaningfully across regions in early 2026 as most regions are exhibiting higher 12-month forward earnings expectations now than at the start of the year. This follows last year’s ex-U.S. multiple expansion, suggesting the fundamental support for those higher valuations is starting to take shape. While this underpins the year-to-date rally in international markets, we continue to emphasize the structural advantages the U.S. maintains in profitability, innovation, and sector composition — factors that may limit the longevity of a full-scale rotation abroad.
Beneath the global surface, earnings revisions remain uneven. Japan shows the strongest and most broad-based momentum, with upgrades across Industrials, Financials, Information Technology (IT), and Communication Services. China is also seeing sizeable upward revisions, though concentrated in Communication Services, Financials, and Industrials. Europe is improving but still mixed: Communication Services and Health Care lead, while Consumer Discretionary remains a persistent drag.
Bottom Line: Rare pockets of fundamental strength can be found outside of Technology-related companies in this macro backdrop, supporting complementary exposure outside of the U.S. and across sectors such as Materials and Energy. Despite recent volatility, U.S. Technology companies continue to drive the bulk of earnings growth, and we continue to view them as a core long-term holding within client portfolios.
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