YTD Yield Update (What Yield?)
By Julien B. Booth
April 14, 2021
I hope this note finds you well and enjoying the Spring.
As mentioned in our last note (https://www.brcwm.com/2020/12/22/what-is-your-duration/) we are confronting a vastly altered landscape for financial assets, valuations of these assets, the ability to find safety, and the underlying integrity of the financial markets.
The Federal Reserve and US Treasury have effectively crowded out the ability of risk-averse investors to achieve acceptable returns via 0% interest rates and the massive intervention programs that inject $120 Billion+ monthly (of endless QE into the banking system/markets). We are accumulating new US debt at an unprecedented rate.
Asset price inflation is required by the Federal Reserve/Treasury/politicians as the threat of deflation to a massively indebted country is too great to consider.
We will remain in this somewhat dystopian world for the foreseeable future. The experiment to back away from this market support did not go well in December 2018. https://www.thebalance.com/how-is-the-fed-monetizing-debt-3306126
After 24 years of managing conservative income/value oriented securities coming to terms with an entirely re-ordered system (with more inherent risk) is a bit tough.
Net, net, our investment policy will likely morph (over time) as the securities that we presently own (legacy bonds/preferred with big yields) are called away (2025 range).
Our portfolio yields (book yield/cost) remain from 5%-8%. These bonds/preferreds are absolutely irreplaceable.
Dimitri (https://www.brcwm.com/about-us/our-team/) will take on an increasing role in generating investment ideas as we confront the new landscape. Dimitri has DEEP experience in securities analysis and is the primary portfolio manager for our equity geared accounts. We loathe being forced from safety, but a necessity as we look ahead.
Below you will find a note penned by Mark Grant (wizened sage of Wall Street) that provides greater detail on the “State” of the fixed income markets.
Thank you for your interest and I welcome your questions, concerns or insights.
Yields-Up to Date
Bond yields are a sad state of affairs for most investors. For years, decades, we have relied upon bonds as a steady source of income, cash flows, and capital preservation. They are higher up in the capital structure than dividends and they provided an income stream to fixed-income holders. This is no longer true and has not been true for some time now. The group of affected investors would include insurance companies, pension funds, seniors, retirees, and university endowments, as some examples of who is being seriously impacted.
The disruption in the bond markets began after the financial crisis of 2008/2009. This is when the world’s central banks stepped into the fray to combat the financial crisis of that time. That was all well and good and the Fed and the other central banks made the right decision, but the bond/yield issues surfaced en masse, as the central banks never left the financial markets from that time to now. In fact, they are controlling/dominating the fixed-income markets through the use of their balance sheets and they have distorted the historical use of bonds in the portfolios of individuals and institutions alike.
The total amount of assets for the Fed, the ECB and the BOJ now stands at $21.3 trillion, and they have been on the rise since early 2020. The Fed’s assets now stand at $7.7 trillion while the ECB is at $8.8 trillion and the Bank of Japan is now at $6.6 trillion with no let-up of their assets, and their use of them, in sight.
In the European Union, in Japan, I point out that the central banks have pushed sovereign debt into negative yields, in many cases. They have redacted the history of thousands of years where the debtor paid the lender to borrow money. This is no longer the case for many governments and while the United States has not entered this space yet, and I emphasize “yet,” I think our new Administration will put significant pressure on the Fed to do just that, as the stimulus programs keep rolling out in Congress.
However, even without that political pressure, fixed-income investors in the United States face a dismal market.
U.S. Govt/Credit 1.47%
IG Corporates 2.20%
U.S. MBS 1.74%
U.S. High Yield 3.99%
U.S. Municipals 1.10%
*Data according to Bloomberg
Stare hard at the yields here. Investors are getting a scant 73 basis points in Investment Grade Corporate bonds over Treasuries which is providing, basically, zero and nothing, in the way of protection for credit risk. Then consider the High Yield Index which is but 4 basis points away from its all time low yield. Here you are getting just 252 basis points for credit risk which, again, is “basically, zero and nothing, in the way of protection for credit risk.”
In my estimation there is just no worth in the bond markets any longer whether you consider “Absolute Value” or “Relative Value.” The central banks, on the basis of providing cheap money for their governments, have rigged the game to their governments’ great advantage and to the great disadvantage of investors.
The only spaces to get yields, any longer, that make any kind of rational sense, in my opinion, are in some carefully selected closed-end funds and in some exchange traded funds. The problem here is that both asset classes are complicated affairs, with some 650 closed-end funds and some 2,200 exchange traded funds being available for inspection.
There are about 20 criteria that I use for this inspection which is far more complicated than choosing one bond and considering its credit rating, coupon, and yield. Consequently, most individual investors should get some professional help here as the criteria for investment is a very complicated affair. Then, for the professional investors, such as insurance companies, they are so heavily regulated that they are literally forced to buy bonds and so the fund space just does not work for them in any kind of size.
Now, as bonds mature, or get called, a significant amount of money, which used to be directed into fixed-income investments, has gone into “appreciation plays,” mostly, the purchase of equities, as the off-set to the lack of yields in bonds. This transference has worked reasonably well, so far, with our stock markets at, or near, all-time highs. Yet, it must be said, that additional risk also comes from this transference and that the ugly head of “Loss” could emerge in any market correction.
My summation here does not include the rejection of the 60%/40% notion for many people, and some institutions. It is just that you have to pivot from bonds, to funds, to get yields and cash flows, as fixed-income investments, for the most part, just no longer work.
After 47 years on Wall Street, I can report with 100% accuracy, that the world changes, the market changes, and so you just have to get on with it. You can’t fight time or tides and so the best you can do is adjust to them and I strongly suggest you recognize the diminution in the value of bonds and act accordingly.
“The secret of change is to focus all of your energy not on fighting the old, but on building the new.”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley Securities
Information herein is for general use; is not unbiased/impartial; is current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Opinions are the author’s, not B. Riley Securities Inc., or their respective affiliates or subsidiaries. This is not a research report or solicitation or recommendation to buy/sell the subject securities. Investment factors are not fully addressed herein. B. Riley Securities Inc. and their affiliates may have a proprietary position in the subject securities.