Bonds: Total Market
There has been a lot of doom and gloom about the risks of an inverted yield curve lately. An inverted curve is often seen as the best and most reliable indicator of recession, as it has accurately preceded the last several US recessions. Some are saying this time may be different as market conditions and central bank created stimulus have warped markets. Well, despite the fact that many hate the “this time will be different” mantra, it may actually be true in this case. In particular, the inverted yield curve has only been reliable in the US, whereas in Japan and the UK it is not a good indicator. This means the indicator is by no means universal, and gives weight to the idea that an inversion does not necessarily mean a recession is coming.
FINSUM: The Japanese example is particularly interesting to us as the BOJ has long had extraordinarily accommodative monetary policy. In that sense it may be the best case study for how an inversion could play out this time.
Rates look to be rising quickly. The economy is red hot and the Fed is hawkish, meaning two more rate hikes this year look very likely. With that in mind, investors need to protect themselves from rate risk. That means a lot of sources of income, like dividends stocks and bonds, could become sources of losses. However, fortunately there are numerous ETFs that can help investors earn income while protecting against losses. One such is Pimco’s 0-5 Year High Yield Corporate Bond (HYS). The ETF has a yield approaching 5% and has a duration of just over 2 years, putting it in the low duration category (meaning it has low rate risk).
FINSUM: This seems like a good option if you want to earn high rate-protected income. Given the current rate environment, funds like these should probably be a fixture of most portfolios.
If there were ever a time to be worried about rate risk it is now. The US economy is red hot and the Fed continues to look hawkish. Two rate hikes by the end of the year look like a certainty. So how can one protect their portfolio? One answer is floating rate bonds, and especially floating rate investment grade bonds with a range of durations. One ETF that does just that is the X-trackers Investment Grade Bond – Interest Rate Hedged ETF (IGIH). The ETF sports a yield of over 3%, and very importantly, it has a duration of almost zero, meaning it should be almost completely unaffected by any movement in rates.
FINSUM: a 3% yield with no rate risk sounds like a very good investment in the current environment.
This is a tough time to be buying bonds. Prices have become very rich over the last several years and on top of sky high valuations and low yields the risk of rising rates causing big losses is high as the Fed sticks to its hawkish path. With that in mind, floating rate bonds and ETFs are a good strategy to combat the situation, as their yields rise as the market’s do. Most also invest in short-term bonds to lessen interest rate risk. Two of the most popular floating rate ETFs are the iShares Floating Rate Bond ETF (FLOT) and SPDR Blmbg Barclays Inv Grd Flt Rt ETF (FLRN). Both hold floating rate bonds with maturities of 5 years and under.
FINSUM: These seem like good options. The one downside to these ETF is that yields are quite low given their conservative nature, but they obviously have great downside protection.
The Fed looks set for another hike in September, and likely another before the end of the year. That means that fixed income is a very tricky market, as many bonds will likely see losses. So how can one protect their portfolio but still earn reliable income? One option is to buy floating rate bonds. Luckily, there are several funds that can help investors own floating rate bonds. Some of them include the Fidelity Floating Rate High Income (4.36% yield), the iShares Floating Rate Bond ETF, the BlackRock Floating Rate Income Strategies Fund, or the Eaton Vance Floating Rate Income Fund.
FINSUM: We think floating rate bonds seem like a good strategy for the current environment. Just be careful of high credit risk in some of these funds.
You wouldn’t usually think of muni bonds when you are looking for juicy yields (at least not investment grade munis). However, if you look further out on the yield curve, there are some very interesting bonds. For instance, there are AAA rated 15-year munis yielding 2.7%, up from 2.2% earlier this year. Comparable two-year munis have just 1.7% yields, representing a 100 basis point spread versus the treasury market’s 29 bp spread. This is the steepest the muni yield curve has been since 2000, which creates opportunity at the long end of the curve.
FINSUM: Most advisors will be aware that even with the currently low yields in munis, the tax exemption for high income clients make the bonds very attractive, so this is just icing on the cake.