Should You Worry About Rising Interest Rates?
Look past the 10-year Treasury yield. Smart investors cast a wide net.
The recent rise in U.S. long-term interest rates blew in suddenly enough for headline writers to dust off fraught phrases such as “bond rout,” “investor boycott” and “tantrum.” (Most bond prices sink when interest rates rise and vice versa.) Talk of a burst bubble colors the financial news here and there; it applies to stocks on a bad day, but more openly and brazenly to bonds. (For more on bubbles, see Are Stocks in a Bubble?) The Federal Reserve seems impatient for inflation to reach 2% and stay there. And inflation expectations heavily influence bond traders’ behavior.
But might this fear and loathing be overblown? The broad Bloomberg Barclays Aggregate Bond index is down 3% so far in 2021. The losses are less for municipals and mortgages, more for long Treasuries and investment-grade corporate debt. To drop 3% is equivalent to kissing away nearly two years of yield, but after consecutive annual 8% total returns, this is far from a bond “rout.”
So, then, should you reallocate your income-generating money? Or simply delay investing new dollars into longer-duration taxable bonds and bond funds? I have no objection to the latter. But I dislike dumping long-successful investments because of transitory problems. Even after rising from 0.52% in August to 1.6% recently, 10-year Treasury yields are less than the 1.9% at the outset of 2020. And before you assume 1.6% is a whistle-stop on the way to the 3% T-bond yield last seen in 2018, you can watch for powerful defensive fire from the various financial bulwarks and citadels. “The Fed can be creative on how to taper its bond buying and not create real stress on long-term rates,” says BlackRock bond chief and portfolio manager Rick Rieder, who also maintains that automation and other technologies will restrain inflation.
Congress and the White House also do not want to risk an investor rebellion so early in the new administration. “The stimulus itself is not enough [to cause severe trouble for bonds] if the economy is still shaky,” says Anders Persson, Nuveen’s global fixed-income chief. Plus, the growth hopes stemming from COVID vaccines and the moderately inflationary spike in oil prices are baked into the fresh interest-rate and inflation numbers. That also implies interest rates will not spiral upward all year.
Look to the pros. Now is the time to rely on good managers to find opportunities. “We’re going back to the old playbook,” Persson says. That means bottom-up credit analysis and looking for the sectors and types of bonds (and preferred stocks) that will benefit from the gradually improving health of banks, energy firms, retailers and real estate. Through March 5, a few bond yardsticks are in the green for the year. One is the S&P Municipal Bond 50% Investment Grade/50% High Yield index, up 0.4%. You can copy it with a combination of a high-yield muni fund such as Nuveen High Yield Municipal (symbol NHMRX) and an actively managed high-grade muni fund, such as Baird Strategic (BSNSX) or Fidelity Intermediate-Term Municipal Income (FLTMX).
With stocks, hunt for dividends. Plenty of cash tops off already rich corporate balance sheets, and dividend-oriented sectors including heavy industry, finance, transportation and energy infrastructure all theoretically benefit from the stronger economic growth. Bank stocks are no longer giveaways, but you can still get 3% to 4% dividend yields on newly invested money. Do not rush to cash out profits. The likes of 3M (MMM, $181), Illinois Tool Works (ITW, $210) and United Parcel Service (UPS, $164) offer above-average yields and have earnings momentum. Utility shares are at the lower end of their trading range. So are Verizon (VZ, $56) and AT&T (T, $30). Keep calm, then, and look past the 10-year Treasury yield. Smart investors cast a wide net.