Bonds Are Safer Than They Look

Yes, there’s plenty of bad news: credit downgrades, bond defaults and dividend cuts. The solution is to find workarounds.

(Image credit: Getty Images)

During a tumultuous past few months, financial markets somehow kept their bearings. Skeptics insist this is a mirage and that an echo of March’s crash is nigh. I contend the run of positive returns is legitimate, but my bullishness is not unrestrained. There is no denying the disruptions from 11% unemployment, travel bans and the potential dangers of attending school or using public transportation.

But my job is to interpret the investment scene and guide you to secure interest and dividends. (By the way, to all who asked where I’ve been the past couple of months: I took a break to contemplate retirement because I turned 65 but decided to carry on.) Although we’re seeing more credit downgrades, bond defaults, and dividend cuts and suspensions than before the pandemic, these impairments are not so widespread that you cannot work around them. For every supine sector, one or two more are in full recovery or at least steady, and they beat zero yields from the bank. My take on key sources of income:

Dividends. Since March, cuts or suspensions hit daily. When Annaly Capital Management (symbol, NLY (opens in new tab))—a high-yielding security whose sole appeal is dividends—cut its payout by only 12%, the shares rallied. Aside from mis­managed outfits such as Boeing and Wells Fargo, and outside of oil and gas, travel, and retail, painful cuts are rare despite the drastic economic contraction. Even at 27,000, the Dow Jones industrial average still yields 2.4%. Yes, raises are shrinking as earnings and growth prospects wither. ADP (opens in new tab), Caterpillar (CAT (opens in new tab)), Illinois Tool Works (ITW (opens in new tab)), Sherwin Williams (SHW (opens in new tab)) and other spectacular 2019 dividend boosters will not repeat those leaps in 2020 and 2021. But you will get some fair incremental raises. Dividend-growth strategies still make sense—but pass on Big Oil.

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High-quality corporate bonds. Despite a bulge of new issues as the pandemic spread and companies went crazy raising cash, demand for bonds still overwhelms supply. Combined with low and sticky interest rates, this is an ongoing bonanza for segments such as A-rated to triple-B-rated U.S. cor­porates. The S&P index of BBBs has a total return of 21% since its March bottom and 8.6% for the year to date. The yield spread between BBBs and Treasuries in early August stood at 1.8 percentage points. That gap is wider than it has been almost continuously from 2016 until early 2020, signaling more room for appreciation if you either own a good bond fund (or two) or hold individual bonds in stable industries with coupons of 5% or 6%.

Municipals. There are problems implied by shortfalls in local tax revenue and falling big-city property values and office rents, as well as the cancellation of conventions and sporting events. But heavy demand, the absence of valuable personal tax breaks and the promise of help if needed from the Federal Reserve are all strong supports. Just apply the normal rules: Avoid bonds from poor or shrinking jurisdictions; lean toward debt for essential services, such as schools and water and sewer lines; and either buy bonds singly or use actively managed funds instead of index-based exchange-traded funds.

Real estate and utilities. Property real estate investment trusts come in 16 subsectors, and the carnage is still concentrated in New York City offices and in retail and lodging. You’re getting paid everywhere else, helped by REITs refinancing their debt at lower rates. Utilities are weak because power demand is down. Plus, the group entered the year touching the sky. But most dividends are secure. And, as we know from previous slumps, income is an antidote to the worst damage.

Jeffrey R. Kosnett
Senior Editor, Kiplinger's Personal Finance
Kosnett is the editor of Kiplinger's Investing for Income and writes the "Cash in Hand" column for Kiplinger's Personal Finance. He is an income-investing expert who covers bonds, real estate investment trusts, oil and gas income deals, dividend stocks and anything else that pays interest and dividends. He joined Kiplinger in 1981 after six years in newspapers, including the Baltimore Sun. He is a 1976 journalism graduate from the Medill School at Northwestern University and completed an executive program at the Carnegie-Mellon University business school in 1978.