Bonds: Total Market
Safe 5% yields sound very enticing right now don’t they? Well, they are actually not as hard to find as you think if you take a broader perspective. That perspective is to look at standard municipal bonds and examine their real-world yields, or how they compare to taxable bonds. For instance, for a couple living in California with a $250k per year income, a municipal bond yielding 3.0% is equivalent to a taxable bond yielding a whopping 5.8%. This is because of the new tax system brought in by Republicans. One muni expert comments that “I would argue that munis are more attractive than they’ve ever been because, with the loss of various deductions, including SALT, one’s taxable income is higher than it’s ever been”.
FINSUM: This is a very good insight and one to which HNW individuals and advisors need to pay attention. Once investors really come around to this, it could spark a muni bond run.
US Treasuries took a nose dive last week on fears over Italy. They fell from well over 3.1% to well under 2.9% very quickly. However, don’t get used to those levels. The reason why is that the underlying economy is fundamentally solid, with wages and jobs strong, growth solid, and corporate tax cuts likely to give a boost. The Fed also seems likely to continue hiking, even if only slowly.
FINSUM: All these reasons aside, our own view is that yields were on a solidly rising path until the Italy issue. Since we seen that as only a temporary problem (for global markets), we suspect bond investors will regain their views.
Credit rating agency Moody’s has just put out a broad and scary warning to investors: when the economy turns around, we have may have a junk bond crisis on our hands. Moody’s says that there will be widespread junk bond defaults in the next recession stemming from huge issuance and heavy indebtedness. With rates so low following the Crisis, indebted companies issued hugely risky and burdensome debt that was eagerly gobbled up by investors. According to Moody’s “The record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives”.
FINSUM: All that issuance was always going to come back to bite. Credit-worthiness was low and investors gave up a lot of safeguards. It seems inevitable the bill will come due.
Investors beware. US equity prices now seem to be entirely at the mercy of bond yields. Stocks have consistently struggled as yields have moved higher, and today Treasury yields seem to have broken an important threshold. Treasuries traded as high as 3.13% this morning, the highest level in seven years. Stock markets unsurprisingly fell. The markets were initially spooked by a solid US retail sales report that seemed to indicate the Fed might hike more aggressively than expected.
FINSUM: Yields definitely seem to have a strongly upward trend at the moment and have definitively broken out of that 2.9% band they had been locked in for a few weeks. Next stop 3.50%?
Stock markets are moving sideways, bond yields are shooting higher, and there is a great deal of uncertainty about the direction of the economy. Investors are understandably nervous. With that in mind, Barron’s has published a piece outlining the best places to park your or your clients’ cash. The answer is short-term bond funds, which are almost all yielding over 2% and have significant insulation from losses related to rate rises. For instance, the Vanguard Short term bond fund is yielding 2.76% and has only lost less than 1% this year despite rises in yields. ETFs that track floating rate bonds are also a good idea given the environment. For example, the iShares Floating Rate Bond (FLOT), which yields 2.21%.
FINSUM: Short-term bond yields are finally significantly higher than equity yields, which means there is at last a good, and likely less risky, alternative to stocks.
The long-time biggest bond shop on Wall Street (actually they are in California) has just put out a stark warning to investors—ten-year Treasuries are going to hit 3.5% in the near term. The manager thinks yields will make it to that level this year but then stall. Above 3.5%, they say, yields would have a detrimental effect on growth and that as yields rise investors will be moving their money into different asset classes.
FINSUM: A 3.5% yield on the ten-year would be a pretty attractive proposition to many, and it seems likely that given how that figure would be simultaneously appealing and a warning of poor future growth, investors will likely move out of equities.