The trend among fixed income ETFs remained largely unchanged last week, with high yield (JNK) and international inflation protected securities, it is important to pay attention to the three drivers behind the credit market: duration (long vs. short maturity), credit spread (junk vs. investment grade), and international (emerging market debt).
Assets Class | Symbols | 02/04 Trend Score | 01/28 Trend Score | Direction |
High Yield | 5.55% | 4.06% | ^ | |
International Inflation Protected | 3.5% | 2.58% | ^ | |
International Treasury | 1.77% | 1.25% | ^ | |
Short Term Credit | 0.17% | 0.71% | v | |
Treasury Bills | 0.0% | 0.02% | v | |
Emerging Mkt Bonds | -0.05% | 0.12% | v | |
Short Term Treasury | -0.15% | 0.3% | v | |
Intermediate Term Credit | -0.48% | 0.92% | v | |
Long Term Credit | -0.81% | 0.99% | v | |
Inflation Protected | -1.33% | 0.49% | v | |
US Total Bond | -1.35% | -0.07% | v | |
New York Muni | -2.14% | -2.14% | v | |
MBS Bond | -2.57% | -1.09% | v | |
Intermediate Treasury | -2.78% | 0.26% | v | |
National Muni | -3.11% | -1.98% | v | |
10-20Year Treasury | -3.48% | -0.71% | v | |
California Muni | -5.35% | -4.61% | v | |
20+ Year Treasury | -5.56% | -2.95% | v |
The trend score is defined as the arithmetic average of 1, 4, 13, 26, and 52 week total returns (including dividends reinvested)
From the table we observe that two major themes – durational risks of long term government bonds, inflation pressures in emerging markets – are driving the poor performance of long term US Treasury bonds, as well as the recent uptick in international inflation protected bonds.
Artificially low rates are not sustainable in the long run
The rock-bottom interest rates maintained by the Federal Reserve have created an environment to sustain the highly leveraged and asset-based nature of the U.S. economy. This approach has certainly benefited speculative borrowers and financial institutions, but the Fed is essentially subsidizing borrowers at the expense of savers. But artificially low interest rates will not be able to stay here forever.
And we have seen signs where funds negatively exposed to durational risk have suffered as a result. The 20+ Year Treasury Bond fund (TLT) has been hit hard, suffering more than 9% drop in the past three months. Principal losses are not at all impossible if the coupons on long-term fixed income assets cannot keep with the inflation in a rising interest rate environment.
Key to search for safe credit spread
Funds composed of well-picked bonds with strong credit profiles and earnings potential that are likely withstand an array of adverse economic scenarios should be at the core of building a fixed income portfolio. It’s challenging to find attractive credit spread in the current environment, but we believe that JNK and KYG should remain as good momentum plays in the near term.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
