Displaying items by tag: bonds
Muni bonds are seeing yields way above average right now even as Treasury bonds linger near all-time lows. The reason why is that it is increasingly apparent that there has been a huge erosion in municipal credit quality alongside the lockdown. Costs have surged at the same time as revenues have plummeted, leading to a significantly deteriorated financial picture for municipal issuers. The has been exacerbated by the fact that municipalities have largely been unsupported by the Fed as opposed to corporate issuers. But the sell-off has created opportunity, as even AAA issuers are seeing big discounts and much higher than usual spreads to Treasuries.
FINSUM: This is all about careful credit selection, as there are big opportunities, but there may also be major pitfalls.
The bond market is usually ahead of the stock market in predicting and reacting to the economy. It seems to be doing so again. While stocks have had a huge run higher, bond yields have largely been stuck at very low levels. The ultra-low yields of around 0.7% on the ten-year Treasury mean that bond investors see a long, hard, recovery looming and many years of continued aggressive monetary stimulus by the Fed.
FINSUM: Stocks seemed to have gotten a dose of realism over the last two weeks, but yields may be more reflective of the difficulty of the recovery to come.
One of the aspects of this bear market that has really alarmed investors is the speed with which the market has rallied from its lows. Huge gains of well over 35% have shocked investors into feeling like indexes are bound to fall again. In some sense that sentiment makes sense since it has happened before, such as in the dotcom bubble. However, according to BlackRock, it is absolutely time to go risk-on, but with a twist. The asset manager says that sovereign bonds have very little upside or protection to offer right now, so instead investors should put their capital into credit and higher-quality equities. “Over the next six to 12 months, we favor credit over equities given bondholders’ preferential claim on corporate cash flows and prefer an up-in-quality stance in equities”.
FINSUM: We particularly like the argument about sovereign bonds not offer much right now. With central banks already at their zero lower bound and sovereigns priced very highly, there is just not much to gain and plenty to lose.
The muni market is at an interesting crossroads. There have been big fears that the current lockdown might be a huge negative for muni credits. The lockdown not only raises costs, but it constrains tax revenue at the same time. On its own, this is a big threat. However, the Fed has set up a liquidity facility particularly for states and municipalities to borrow, which is a major help. That said, analysts say some credits will be excluded. The problem is that the Fed has put limits on the size of cities and counties able to participate, as well as fairly onerous language, such as municipalities having to promise that they cannot “secure adequate credit accommodations from other banking institutions”.
FINSUM: The Fed’s restrictions on this program are surely going to constrain its efficacy. So, on the whole this seems like good news, but not as good as investors would like.
This is a difficult time to be any kind of investor, but being one trying to get yields out of equities is particularly hard-bitten at the moment. Dividends are being cut left and right, so investors need to turn to other options, but much of fixed income looks very scary. That said “Quality yield is on sale”, according to a fund manager at Tocqueville Asset management who specializes in income investments. “Don’t ignore the rest of the capital structure”, says another fund manager at Socoro Asset Management. For instance, look for things like a JP Morgan Chase preferred security with a fixed coupon of 5% and yield-to-call of 7.72%, or Invesco’s Variable Rate Preferred ETF (VRP), yielding 4.85%.
FINSUM: These are good suggestions. For a yield that will really knock your socks off, take a look at the Virtus Private Credit Strategy ETF (VPC), which owns many BDCs and CEFs and has been beaten up in the selloff, but yields a whopping ~18% net of expenses.