Bond Values in a Volatile Market
While the market's instability may not be over just yet, the latter half of the year should be less daunting – and possibly more rewarding – for investors.
Steel yourself for six more months of instability.
The model: In May, the Federal Reserve hiked short-term interest rates by half a percentage point, the most in a single adjustment since 2000, and promised to do it again and again until inflation slows.
Stock prices curiously rallied as long-term interest rates fell back, also generating gains for bonds and bond funds. But after a night to contemplate, the rabble of day traders, debt-and-inflation scolds and Fed cynics undid the gains and then some, in both bonds and stocks. This turbocharged the fears of an extended and all-encompassing decline as oil prices re-escalate, high mortgage rates strangle the housing boom, and jobs, business profits and consumer spending gradually weaken.
In such a world, everyone with diversified savings and investments is in zugzwang, the chess player's trap where every possible move makes you worse off. The preventative to that is to find risk-free refuge. I’m seeing one-year certificates of deposit paying 2%. It has been a while since that was on offer. Grab it if you have had your fill of turbulence.
But I am not equating volatility with hopelessness. Plenty of higher-income-paying stuff, despite being in the red so far in 2022, looks oversold. Hence, I forecast better results in the second half among key yield-oriented sectors: taxable and tax-exempt municipals, preferred stocks, utilities, real estate investment trusts (REITs), and corporate bonds rated A and BBB.
The few actual first-half winners are also still safe. Energy investments will continue to thrive, floating-rate funds remain timely, and you can now accumulate two- to five-year Treasuries with respectable coupons. If you are watchful, you will get chances to buy quality bonds, funds and bond-like assets on dips. Don't fret about missed or reduced dividend or interest payments. You are more apt to get a raise.
Most of the Market's Losses May Be Behind Us
After interest rates have risen as they have, and with slower economic growth increasingly likely, I cannot see another two quarters of 10% principal losses in short- and intermediate-duration debt. How much more bond selling makes sense, especially as the yield curve flattens and long-term Treasury rates stop climbing so much?
A bunch of fixed-rate preferred stocks with tax-advantaged dividends are nearly 20% below their $25 par value, and similarly rated issues (around BBB-minus) from such financial luminaries as Allstate (ALL), Bank of America (BAC), Capital One (COF), Morgan Stanley (MS) and U.S. Bancorp (USB) are priced for a current yield at or above 6%.
The rare year-to-date slide in municipal bond prices followed a long spell of outperformance. Now, munis dated 10 years and longer are commonly priced to yield more than equivalent-maturity Treasuries – a buy signal for tax-exempts, and that is before you calculate your taxable-equivalent yield, which may exceed 7%.
The war in Ukraine is a boon for domestic energy investments. A raft of 10- to 20-year issues from oil and natural gas firms, pipelines and related industries, rated investment grade or just below, are priced to yield 5.5% or 6% to maturity, with the possibility of price-boosting credit upgrades.
You get dramatically more value in a number of areas today. That is why I am confident the balance of this year will be less daunting, and possibly more rewarding, than the beginning – at least for discerning investors.