Pockets of opportunity still lurk in bonds

A rash of corporate debt downgrades lies ahead, but actual defaults will remain low. So, is the worst over?

  • By Jeffrey R. Kosnett,
  • Kiplinger
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Bonds survived a brutal financial upheaval, reinforcing my confidence that positive returns will extend through the remainder of this strange year, albeit with massive help from the Federal Reserve. There will be more bad days and shrill headlines, and you can expect a bulge in corporate debt downgrades to junk status in the most-depressed industries and localities. But actual defaults will remain low. And there will be no magical economic boom to send interest rates flying and slash bond returns.

Consequently, your principal will be okay and income reliable. This is in sharp contrast to that hour-by-hour maelstrom of emotion called the stock market. With few exceptions, corporations, states, municipalities and public-service authorities have the cash flow and reserves to meet their interest obligations. The Fed is buying big-city bonds. The U.S. government pays Treasury debt and backstops gazillions of mortgages. And in April, Fed chairman Jerome Powell said he is “not concerned about the financial system collapsing as in 2008,” noting that banks are lending, credit is flowing, and sound companies (and even some not-so-sound ones) find ready buyers for new bond issues.

Yes, airlines and firms in the travel-leisure-convention-sports complex are in a bad way. Oil companies are going belly-up, as will some suppliers. Many have junk debt trading for 50 cents or less on the dollar. Energy bonds still rated investment-grade are rickety. So, what to hold and what to avoid for the rest of 2020? Let us go down the list.

Treasuries. As the world’s lockbox, Treasury debt sells no matter how big the volume or how low the yield. You’ll break even on the principal, but do you want less than 1% forever? You can find risk-free federally insured savings accounts paying 1.5%.

Mortgages. I like funds holding bonds backed by the Government National Mortgage Association because of the full faith and credit guarantee. You are shielded from missed mortgage payments and foreclosures. Fidelity GNMA (FGMNX), T. Rowe Price GNMA (PRGMX), Pimco GNMA (PAGNX) and Vanguard GNMA (VFIIX) are all good choices. Avoid non-government-backed commercial mortgages, such as in most mortgage real estate investment trusts, even though they’ve already crashed. Indiscriminate or desperate bottom-fishing is unwise.

Municipals. There are sectors in peril—nursing homes, for one—but general obligations and school, highway and water/sewer bonds are sound and beckon to fresh buyers with excellent taxable-equivalent yields. Use actively managed, low-cost mutual funds, where the pros find numerous opportunities to pick and choose. Kiplinger 25 member Fidelity Intermediate Muni Income (FLTMX) is fine.

Corporates. At one point in March the index of triple-B-rated bonds was down 10% for the year. It is now just above breakeven, and the losers are crowded into a few sectors. I look for actively managed funds to have a good second half. Vanguard Intermediate-Term Investment Grade (VFICX) holds nearly 2,000 bonds and shouldn’t get tripped up by one rogue sector.

Foreign bonds and emerging markets. Just say no. Nein. Nada.

Junk bonds and other high-yield credit. The worst is over for business development companies and floating-rate bank-loan funds, but if the economy doesn’t regain positive momentum this year, look out below again. That’s not what we’re expecting, but I’d stick with senior and secured debt with high ratings, from good borrowers you recognize and understand.

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© 2020 The Kiplinger Washington Editors, Inc.
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