I have long described our current investing environment as a "Borrower's Paradise" and a "Fixed-Income Investor's Hell." The situation has not changed and continues along unabated. The reason for this is really just one thing: the Fed. The reason for its posture is also just really one thing, and that is its interference in the markets to keep interest rates very low for the benefit of the U.S. government.
The government has borrowed heavily and has exceeded our GDP as a logical response to our coronavirus pandemic. I take no issue with what either the government or the Fed has done, but the flip side of this coin is the decided lack of yield, which has evaporated with the actions of the Fed.
Consequently, there have been intended actions and unintended actions that have accompanied the moves made by the Fed. The first, and most important, is that investors can't find any decent yields in almost anything. The one exception, in my view, is closed-end funds. They use leverage, they are complicated, but, as the most overlooked part of the markets, they still provide some decent yields. You can even find bond funds that pay monthly and that have double-digit yields. Some hold investment grade portfolios and some high yield, and in each case, the leverage component has now been significantly minimized, as they can borrow at just this side of zero. Also remember that it is the fund's leverage and not your leverage, so that you are not on the hook.
One unintended consequence of the Fed's position is that the risk premium for corporates, high yield, mortgage bonds, and the like has also been significantly minimized. The Bloomberg Index for U.S. Treasuries, with a duration of 7.2 years, now indicates a yield of 0.49%. The corresponding U.S. Investment Grade Corporate Index now yields 1.94%. This indicates a spread of just 145 basis points over Treasuries. The meaning here is that there is almost no value for the credit risk in corporate bonds. In other words, you have more risk than Treasuries, but you are not being paid for taking it.
In a more normal environment, we are always talking about "Relative Value." This is one bond versus another bond or one fixed-income sector versus another sector. The discussion can still be had, but the overriding issue now is "Absolute Value." There is virtually no yield for your money at the bank, about the same for money market funds, and short corporate yields are just back of Treasuries by a fraction of a point.
This is all being driven by a significant "hunt for yield" and, almost none being found, it is pushing seniors, retirees, pension funds, university endowments, insurance companies into more and more risky assets as a result. It is also one of the main reasons, in my estimation, that equities have fared so well this year. The "hunt for appreciation" takes a new leg up when the "hunt for yield" bears no fruit.
Moreover, one administration or another, as our election nears, I expect no significant move in the Fed's current policy. One government, another government, and both are going to push on the Fed to hold our interest rates at historically low levels. Our forthcoming election may bring all kinds of changes, but I don't expect our interest rate environment to be one of them.
For those of you with bonds in your portfolios, I have several suggestions. If they are now trading at a significant premium, they deserve a hard look. Almost all bonds mature at par, and so, to take some bond profits now and re-invest both the principal and the premium may be one smart move on your part. I have also been suggesting this to my institutional clients. Our historical low yields present an opportunity for the savvy investor to take advantage of many premiums that now exist. A few simple calculations will guide you in the right direction.
If you own a bond, as an example, that is now trading at 115 and you own 100m of it, and sell it and then re-invest not the 100m but the 115m, you may be ahead of the game. This is true especially if you buy some double-digit yielding closed-end bond funds and get a monthly dividend and not the normal semi-annual payment on some bond. While all of the talk in the media is about the stock markets, there are still opportunities in the bond markets, if you know where to look and find them.
I also point out that "appreciation play" risks are magnifying as we head into our election results. Without doubt, in my opinion, we will have increased volatility and perhaps a meaningful correction in equities. The smart investor will have some additional cash going into the election and perhaps some out-of-the-money puts on any profitable positions. "Preservation of Capital" is still Grant's Rule number 1 through 10. It is far easier to keep the money that you have rather than making new money, especially when great uncertainty lies just ahead in our future.
On November 4th, the American people may wake up and echo Alice's comment:
"It's no use going back to yesterday, because I was a different person then."
- Wonderland
You should protect yourself against this possibility. Going through the looking glass has consequences.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
