Deep Dive video: How to invest in fixed income (8:15)
CIO's Carolina Corvalan shares why it's the right time for fixed income, and what investors can consider.

Thought of the day

The S&P 500 closed 1.4% lower on Wednesday, the worst day since April, amid investor anxiety that strong private sector job creation figures raised the risk of a further rate hike from the Federal Reserve. Investors also continued to digest the implications of the decision by credit rating agency Fitch to downgrade the US government's sovereign credit rating. Technology stocks led the decline. The FANG+ index, which tracks the top 10 most traded US technology stocks, fell 3.5%. All constituents of the index declined.

The return of market anxiety after three consecutive weekly gains in the S&P 500 was also reflected in the VIX index of implied stock volatility, which rose to its highest level since May—consistent with daily moves in the S&P 500 of 1.1%.

Ahead of the official jobs release for July, the ADP gauge of private sector employment was stronger than expected—pointing to a 324,000 increase for the month versus consensus expectations for 175,000. Our base case remains that Fed rates have already peaked for the cycle. But with two more consumer price inflation readings and two more monthly jobs releases before the Fed's next policy meeting in September, investor sentiment could continue to shift.

Against this uncertain backdrop, we recommend investors to:

Lock in quality bond yields. The more defensive, higher-quality segments of fixed income look most appealing to us, given the all-in yields on offer and the potential for capital appreciation as investors shift their focus from inflation risks to growth risks. We expect high grade (government), investment grade, and sustainable debt to deliver good returns over the balance of the year, and we prefer five- to 10-year maturities.

Use capital preservation strategies to protect against downside. After strong year-to-date returns for US, growth, and IT stocks, investors need to think about how to balance potentially attractive longer-term gains with elevated valuations and near-term risks. In our view, the risk-reward of direct exposure of these areas is relatively unappealing versus asymmetric exposure. As a result, we recommend that investors make use of capital preservation strategies to maintain both upside exposure and some downside protection.

Look for equity laggards. Stock market gains have recently been concentrated in a few areas, and with valuations among some of the best performers now looking stretched, we expect the gap between the leaders and the laggards to close. Investors should rebalance into the laggards, like emerging markets, defensives, and value. This process was evident in July, with the equal-weighted S&P 500 index slightly outperforming the main index, while Chinese and emerging market stocks did even better than developed markets.

So, while we see opportunities across asset classes, we are most preferred on fixed income relative to equities.