Spread out for income across bond sectors

Bottom line up top:

• Big tech earnings pass the test. First-quarter earnings season for the S&P 500 Index is hitting its stride, and last week featured good news for some key mega-cap "magnificent seven" tech giants. Last week's batch of reports helped lift stocks out of their recent slump, as the S&P 500 had retreated more than 5% through the first three weeks of April. Looking ahead, analysts lean mostly constructive, with forecasted earnings per share (EPS) growth of 3.5% for the first quarter, according to FactSet as of 26 April. For 2024 as a whole, analysts now expect EPS for the S&P 500 to grow 10.8%, improving to 13.9% in 2025.
• Earnings results may bring clarity, but monetary policy remains hazy. Recent macroeconomic data and cautious central bank rhetoric have been signaling a need to delay rate cuts, a trend that was reinforced on Friday. The Personal Consumption Expenditures (PCE) Price Index - the core version of which is the Fed's preferred gauge of inflation - came in marginally above estimates for March, at 2.8% year-over-year. The PCE reading wasn't as bad as markets had feared, but offset the dovish tone set by a weaker-than-expected first-quarter GDP growth report and the preliminary U.S. Purchasing Managers Index (PMI) for April released earlier in the week. Both the manufacturing and services PMI components surprised to the downside, hitting multi-month lows and hovering near the 50 level that separates expansion from contraction. The combination of an upside surprise in inflation and a downside surprise in the pace of economic activity complicates the Fed's efforts to engineer a soft economic landing. Central banks outside the U.S. may be in the same or a similar policy conundrum as the Fed (Figure 1), although the Bank of Japan remains a notable outlier, looking to raise rather than cut rates as the Japanese economy continues to emerge from decades of deflation.
  
  In general, instead of attempting to position portfolios to match the frequently shifting winds of rate cut expectations, we think investors with long-term objectives are better served by allocating to economically resilient asset classes and market segments that offer valuation advantages and the potential to out-earn cash.

Portfolio considerations

With anticipated rate cuts being pushed out until later in 2024, investors are still benefiting from the highest starting yields in more than 15 years. This means yield income remains the primary contributor to fixed income total returns, helping offset near-term price declines. Across most taxable fixed income sectors, spreads are modestly tight, but securitized assets stand out for the relative attractiveness of their spreads (Figure 2). Within the securitized space, we're finding compelling opportunities in asset-backed securities (ABS), nonagency mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS).

• ABS consumer and commercial credit performance continues to show signs of stabilizing. Default rates are in line with pre-pandemic levels, yet yields are significantly higher.
• Yields for MBS rated BBB and lower look attractive given healthy fundamentals and spreads that are comparable to or better than those of other areas of the market.
• As for CMBS, there's substantial reward potential for investors willing to accept the risks and challenges facing office and retail properties. Delinquency rates for the lodging and retail sectors have improved markedly over the past two years.

Spreads on preferred securities have compressed by 50 basis points (bps) year-to-date, leading to some of the best returns within fixed income. We expect preferreds to continue to benefit from technical tailwinds, such as constrained supply amid low net issuance this year, as well as from sound underlying fundamentals for investment grade financial services companies. Preferreds also offer a compelling 7% yield. Among different types of preferreds, we favor $1000 par securities and contingent capital securities, also known as contingent convertibles (CoCos), as these two segments provide high levels of income per unit of duration.

The floating rate structure of senior loans tends to help them weather periods of higher interest rates. Currently, these loans are yielding north of 9%, making them one of the highest-yielding investments in any asset class. Individual investor demand for loans was robust in the first quarter, with inflows at $2.8 billion - a trend that we think will persist as investors continue to seek income while protecting against the risks of a delayed rate-cutting cycle. Within loans, we prefer higher-quality sectors and enterprise revenue business models. Larger issuers with strong free cash flows should be better at managing the elevated interest payments that come with higher-for-longer rates.

Nuveen's Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.

Regular meetings of the GIC lead to published outlooks that offer:

• macro and asset class views that gain consensus among our investors
• insights from thematic "deep dive" discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
• guidance on how to turn our insights into action via regular commentary and communications