Where to seek income in 2020

Look to convertible bonds and dividend-paying stocks as potential opportunities.

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Key takeaways

  • Bad news—as well as good news—is priced into the financial markets, presenting income-seeking investors with opportunities as well as risks.
  • Multi-asset income strategies can invest in a wide variety of income-oriented investments.
  • Attractive opportunities currently exist in convertible bonds, dividend paying stocks, floating rate bonds, and some emerging market stocks and bonds.
  • Prices of preferred stocks and real estate investment trusts have risen to the point where they offer relatively little appeal for income-seeking investors.

From recession concerns to trade wars to political unknowns, there's a lot of potentially bad news that's affecting how investors and traders are valuing stocks and bonds. That makes this a good time for tactical multi-asset income investing strategies, including the fund I manage, the Fidelity Multi-Asset Income Fund (FMSDX). That's because when markets react to or anticipate news events, they may temporarily overprice or underprice assets. Presently, markets are pricing in a higher probability of a recession, yet the economy might only be in the late cycle phase which could continue because many central banks have been cutting interest rates.

Tactical multi-asset investors seek assets that offer high yields and trade at prices that suggest a lot of bad news has already been priced in. That way, if reality turns out to be as negative as the markets expect, prices shouldn't fall much because investors anticipated bad news. If things turn out better than expected, though, these assets could reward investors with higher prices in addition to interest and dividend income.

Where the fund is finding opportunities

Convertible bonds, are more attractive than they've been in years. Demand is strong and lots of new issues are coming to market with attractive terms. Many of the companies issuing convertible bonds are new to the market. Next year, 9% of the convertible bonds in the market will mature. This reduction in supply will help keep prices up, though like all bonds, their prices can fall if interest rates rise.

Dividend-paying stocks also look appealing, partly because of all the bad news that has been priced into some stocks and sectors. Investors' and traders' worries over everything from trade wars to Brexit are helping make this a great time for income investing in stocks. Opportunities exist in dividend-paying semiconductor makers where inventories are down and prices are up. US banks also present opportunities. Their balance sheets are stronger than they have been in the past and their prices are attractive.

Crude oil and product tanker companies are among other stocks that seem to have a lot of bad news priced in, but offer attractive dividends. Oil company stock prices have been driven down partly by negative perceptions of the industry and dividend yields range from 5% to 7%. Markets have also been pricing recession expectations into the stocks of industrial companies. That means there's lots of upside potential if the global economy grows more strongly than expected.

Dividend-paying stocks of drug companies such as Roche (RHHBY), Bristol-Myers (BMY), AstraZeneca (AZN), Sanofi (SNY), and Amgen (AMGN) may also offer upside potential, reasonable valuations, and attractive dividends. Two exceptions to the generally strong prospects for dividend-paying stocks are utilities and consumer staples companies where recession anxieties have drawn investors to these traditional late-cycle favorites and raised prices in the process.

Other opportunities in dividend-paying stocks lie outside the US in stocks denominated in currencies such as the euro, yen, and Brazilian real. Besides offering dividends, the prices of stocks of companies from these countries could benefit if economic growth in the US slows to a level more in line with other countries and the dollar weakens. Remember, though, that stocks are volatile and their prices can fall due to a wide variety of factors.

Floating-rate loans which pay variable rates of interest, also currently offer attractive yields at discount prices. Negative expectations about the direction of interest rates and selling by collateralized loan obligations have pushed prices down and created an opportunity. Yields are attractive today and if rates start to move higher and recession prospects diminish, floating-rate loans could generate superior returns. Remember, though, floating-rate loan values can decline significantly and they can be difficult to resell.

Opportunities also exist among emerging-market bonds, which offer much higher yields than US investment-grade bonds. In exchange for higher yields, investors take on risks, such as the unique political and social circumstances of each country issuing bonds. These risks can make emerging-market stocks more volatile than stocks in more developed markets.That makes it important to understand the issues in these countries. For instance, the Fidelity Multi-Asset Income Fund holds bonds issued by the Brazilian government. In Brazil, inflation is low, the central bank is cutting interest rates as economic growth slows and the currency has weakened on fears of recession. With much of the "bad news" about growth already priced in, bonds denominated in Brazilian reals can offer attractive income, as well the potential to benefit from a weaker dollar, should Brazil's growth eventually bottom.

Another popular category of income-generating investment, high-yield corporate bonds, don't match the compelling opportunities available now in dividend-paying stocks. Bonds with low B and CCC ratings issued by energy companies may represent the brightest spots in high yield presently, though bonds of less than investment-grade quality have greater risk of default or price changes than do higher rated bonds.

Opportunities are also relatively scarce in preferred stocks, real estate investment trusts (REITs) and US Treasurys, all of which rallied strongly in 2019. Banks with preferred stocks have healthy balance sheets but presently offer relatively little value or income. In addition, 20% of the preferred market has negative yield-to-call ratios, meaning the issuer can call those bonds at par value at any time, even though they may be trading higher than that. That's not the balance of risk and reward that we're looking for.

REIT fundamentals are strong in the US real estate market. But like preferred stocks, they've had a tremendous rally and now trade at historically high valuations.

US Treasurys and other sovereign bonds also have gotten more expensive and less attractive as the market has priced in lower interest rates and a recession. They play an important role of providing insurance in volatile markets in our fund but aren't offering much income right now.

Finding ideas

Investors who want exposure to these asset classes should do so through professionally managed mutual funds. Fidelity has a number of tools to help investors screen through mutual funds and ETFs for research ideas. You can run screens yourself using the Mutual Fund Evaluator, or in the ETF or stock research areas of Fidelity.com. Below are the results of some illustrative screens (these are not recommendations of Adam Kramer or Fidelity).

  Multi-asset class income funds Emerging market funds
Fidelity funds Fidelity® Multi-Asset Income Fund (FMSDX) Fidelity® New Markets Income Fund (FNMIX)
Non-Fidelity funds Columbia Flexible Capital Income Fund Class A (CFIAX)
AllianzGI Income & Growth Fund Class A (AZNAX)
Pioneer Multi-Asset Income Fund A (PMAIX)
American Beacon Frontier Markets (AGEPX)
MainStay Cadriam Emerging Markets (MGHAX)
TCW Emerging Markets Income Fund (TGINX)
The Fidelity screeners are research tools provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Expert screeners are provided by independent companies not affiliated with Fidelity. Information supplied or obtained from these screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange-traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.

Next steps to consider

Match ideas with potential investments using our Stock Screener.

Analyze your portfolio and create a clear plan of action.

Learn how to navigate bond market fluctuations.

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