On Wednesday of election week, the Federal Reserve Board issued a statement, and the chairman gave a press conference. Let me summarize the Fed’s message in four words: More of the same.
That’s good news for income markets in 2021. It portends more positive returns, comparable to the 7% in 2020 on investment-grade corporate bonds or the 3.5% on Ginnie Mae mortgage pools. Any sense that inflation, interest rates and economic growth will escalate enough to erode bond values is mistaken, even if a viable COVID vaccine revs consumer and business confidence. Look at it this way, says PGIM Fixed Income economist Katharine Neiss, “A vaccine is less inflationary than a huge fiscal stimulus.”
A mixed and centrist election outcome, assuming it comes to pass after runoff elections for Georgia’s Senate seats, stands to trim the maximum size and breadth of any such 2021 stimulus package. That moderation will restrain long-term interest rates. And the Fed’s explicit policy of lower-for-even-longer short-term yields and its promise to fight anything threatening to spark even a near-recession will keep cash returns near zero. That hardens the floor beneath the value of stocks and bonds.
No shame in looking. The balance of risk and reward that favors higher yields over too much caution has not changed. The question is one of degree. At least investors should start to feel more comfortable about reaching for yield beyond the usual suspects. Says Eaton Vance fund manager Andrew Goodale, “The shaming of people for searching for yield has quieted down.”
As always, there will be some bond market blowups, but beware making sweeping judgments. Do not go wobbly on municipal bonds should Illinois lose its investment-grade credit rating, and do not dis Dividend Aristocrats if ExxonMobil slashes its payout. It is a mistake to sell good investments on news events. If you waited out the worst few weeks this past February and March, you benefited big-time. The markets vindicated the view that high-yield bonds, taxable municipals and preferred stocks were massively oversold, and these holdings maintained their payouts. Even if Illinois were to sink to the same bond rating as Brazil’s, it will not default on its interest payments.
Since 2021 stands to be quieter than 2020, with no election, banks and real estate steadying, and progress on the pandemic, there’s no urgency I can see to withdraw your 2020 profits from the market. A year ago I highlighted the closed-end Nuveen Preferred and Income Term Fund (JPI), lauding its prospects even after a 31% return in 2019. The fund’s share price fell 40% (like so much else) in late February and March, but it regained most of the losses and still distributes 7% annually. After a similar drop in the Flaherty & Crumrine Preferred Income Fund (PFD), a relentless rally delivered a 16% year-to-date increase in share price. It distributes 6% after raising dividends 10% in August. PFD, a closed-end fund, trades at a 20% premium to net asset value, but once that shrinks, it is a buy. (Yields and returns are as of early November.)
I am also a fan of Invesco Taxable Municipal Bond ETF (BAB). Taxable munis yield as much as or more than triple-B corporates—but with triple-A and double-A ratings, arguably sounder revenues, and a huge market of institutions and foreigners who do not need or qualify for a tax exemption. The ETF yields about 3% and has a total return of 6.7% for 2020, on top of 11% in 2019.
Lastly, high-yield bonds retain a handsome yield advantage over Treasuries. Good fund managers, including those at Vanguard High Yield Corporate (VWEHX), are careful to avoid sick sectors and borrowers with cash-flow crises. Goodale calls this “informed risk tolerance.” I call it smart.
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