Bonds: Be Choosy for the Rest of 2021

Six months ago, I forecasted that bonds of all stripes would extend their winnings this year. Then fears of inflation and rising interest rates sent Treasury and corporate bond yields up and sent bond prices, which move in the opposite direction, down 5% or more over the first three months of 2021 – with the exception of high-yield "junk" bond prices.

Although long-term interest rates, including corporate and Treasury yields, leveled off in April and backslid in May, my prophecy of positive total returns is in manifest jeopardy.

Through May 7, the Vanguard Total Bond Market ETF (BND) shows a loss of 2.5%. If that continues, 2021 would be the first down year for this popular yardstick since 2013.

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Even Dodge & Cox Income (DODIX), the gold standard for actively managed general bond funds, is off 1.4%. Active bond managers can still beat the indexes, but no team of managers, analysts and traders can fight off every headwind.

However, as I have written for years, there is more to investing in bonds than riding interest rates. And enough good things are happening in the economy and assorted fixed-income sectors for me to say to stand firm.

Stronger oil prices, better jobs numbers and much sounder than expected state and local government finances all imply, in different ways, better second-half prospects – perhaps not for T-bonds, but for other types of income-driven or debt securities.

For example, giant mortgage real estate investment trust Annaly Capital Management (NLY) is up 11% this year while paying a 22-cent quarterly dividend that is more secure now than several months ago.

I would not argue that the shares of pipeline owner Magellan Midstream Partners (MMP) are like a bond, but Magellan is a reliable fountain of income whose share price is up from $41 as it maintains the same high dividend it delivered through the darkest days of the pandemic.

My go-to floating-rate bank fund choice, Fidelity Floating Rate High Income (FFRHX), yielding 3%, has a year-to-date total return of 2.8%, suggesting that the chances are strong the fund will notch its sixth straight year in the green.

What do these picks have in common? Their high yields, or high fund distributions, continue to attract savers and investors while a tight supply of comparable names supports their prices and economic vigor adds to their appeal. There is now more risk in low-yielding three- to five-year Treasuries than in most bonds "with coupons north of 4%," says Phil Toews, of Toews Asset Management.

The U.S. is poised to make back the economic growth that it lost last year, then return in 2022 to the pre-COVID and super-investor-friendly backdrop of moderate growth and inflation and 2% long-term Treasury yields.

And it will do this at a time when households have built enormous cash reserves, paid down debts and generally regained confidence in the economy and the markets without scaring the Federal Reserve into tightening credit and humiliating us committed bond bulls.

Toward that end, I would add preferred stocks (or funds) and well-managed high-yield bond funds to the shopping list.

If you insist on the full faith and credit of Uncle Sam, a low-cost Ginnie Mae mortgage fund will give you a return that's a percentage point or so better than a Treasury-heavy portfolio.

I still like municipals, which are helped by robust demand compared with their modest supply, as well as congressional aid to transit systems, airports and the like. In all, some of us will still end 2021 with small losses on fixed-income and others with small gains. But the rough first quarter is already a memory.