Right now might not seem like the most important time to buy rate-hedged or short duration funds. The Fed is supposed to be on “pause” after all. However, in our view, now might be a critical time to have some rate hedged assets in the portfolio. The reason why is that yields have pulled back strongly from just a couple of months ago, including yesterday, but given the fact that it is almost purely the Fed which has caused the sharp reversal, rates could swing just as wildly higher if their comments, or economic data, changes. In other words, the bond market looks overbought right now because of Fed comments, but it could easily snap back to where it was in December in violent fashion.
FINSUM: We think this is a time for caution on rates and yields given how strongly the market has reversed over the last couple of months.
There are a lot of good reasons to own Treasuries right now, and a lot of reason to be nervous about them. Let’s take a look. The biggest risks in the market at present are mostly about the budget deficit, which makes Treasuries look weak and inflation likely to jump (as it has historically during such spending). However, there are a lot of positives too. The big one is that the Fed looks ever more likely to adopt a permanently dovish stance as it may be changing its thinking about inflation. Additionally, economic weakness will be bullish for Treasuries, so coming to the end of the cycle is not catastrophic.
FINSUM: The best place to be on the yield curve is clearly at the short end—less rate risk and decent yields.
Picking small caps is an art, a point that any serious investor in the space knows. Well, one of the best in the business is giving out tips today and advisors would be wise to listen. Samantha Lau, co-CIO of AllianceBernstein’s AB Small Cap Growth Portfolio is giving out her “rules” for small cap investing. Her fund has an admirable record, rising an average of 20% per year for the last decade, better than 95% of her peers. Some of her rules: “If you think something is wrong, exit and revisit”, “CFOs don’t quit to spend more time with family”, they leave because they see better performance elsewhere or something bad is coming. She continued “A good company is not always a good stock”. Her team uses a rigorous methodology that mixes quantitative and qualitative factors.
FINSUM: These are great tips for any investor, but we are particularly fascinated by the comment about great companies not being great stocks. It is an interesting and underappreciated point.
The market seems to have forgotten about 2013’s Taper Tantrum. The bond markets appear to feel like they are back in the driver’s seat, and seemingly no one expects the Fed to suddenly turn hawkish. A similar set up existed in 2013 prior to the big market meltdown referred to as the “Taper Tantrum”. The thing to bear in mind is that Fed chief Powell has made clear he doesn’t like being bossed around by the White House or the markets, so will not be afraid to be one step ahead of markets in making a sudden hawkish move. It is important to remember then that a survey of economists shows that they expect another rate hike this year.
FINSUM: The Fed is made up of economists, so that survey could have value. That said, we do lean towards the “no further hikes” in 2019 camp.
If you are of the opinion that rates are not going to move higher, or if just want some great yields and aren’t too worried about rates, take a look at mortgage REIT ETFs. Mortgage REITs are a special subsector of the REIT industry, and have recently become greatly more accessible because of ETFs. For instance, consider the iShares Mortgage Real Estate ETF (REM). The fund has a 30-day SEC yield of 9.36%. It is obviously rate sensitive, but even during last year’s brutal hiking cycle, it only lost 3.75%.
FINSUM: If the Fed stays put this year, which it likely will, these could be a great investment as we head into a downward rate cycle.
Bond investors are getting nervous, and not about the Fed or interest rates. Rather, they are worried about corporate credit. Most will be aware that corporate credit issuance surged over the last decade, especially in fringe investment grade BBB debt. Now, investors are fearing a “wall of maturities”. In the next three years, one third of all triple B rated US debt will come due, a huge test for the group of highly indebted companies. Companies will then need to refinance in this much-less-friendly environment. The Bank for International Settlements warns that in the next downturn, many BBB rated bonds will be downgraded to junk, which will cause fire sales.
FINSUM: Our big worry here is that many institutional investors have strict mandates to not hold junk bonds, so if a solid number of companies fall from the BBB level, there will indeed be huge fire sales in credit markets.