(New York)
Investors seem to have every reason to worry about bonds. Prices are high, yields are low, and low quality companies are accessing easy financing even in the face of an uncertain economic future. With all that said, there might not be any reason to worry at all. Central banks are still gaming the system. From the Fed being really conservative with rates, to the ECB and BOJ doing massive QE, the whole central bank mechanism is conspiring to prop up bond prices in a major way.
FINSUM: As long as that pre-condition of huge central bank support is in place, it is hard to see bonds taking much of a hit.
(New York)
For many, many years muni bonds have been the go-to for tax-free income. While their yields were lower than conventional credits, there was usually a significant cost-savings by investing in the bonds because of the lack of taxation. However, the muni market is so over-bought that it is very difficult to find bonds where that is still the case. Prices have moved yields so low that there are virtually no savings versus Treasuries. 2019 saw muni bonds experience their highest inflows since 2009, and according to Morningstar “For most taxpayers, there’s no longer a significant yield advantage for muni funds after you take taxes into account”.
FINSUM: Weak yields and no savings, which is going to push investors to buy ever riskier munis. Boom time coming for lower-rated credits?
(New York)
Ban of America says it is a very good time for investors to buy TIPS, or Treasury Inflation-protected securities. The bank thinks inflation expectations are going to rise this year and they are bullish on long-dated TIPS. The call is notable as many fund managers lost money with similar bets after the Crisis, when many thought inflation would jump alongside QE. This time may be different as the Fed has explicitly said it would let inflation run hot to compensate for the slow inflation we have had for the last decade.
FINSUM: We just don’t see inflation rising much in the near term. There are still a lot of worries about the economy. We feel like 2019 would have been the year for big inflation worries/rises, but it didn’t materialize.
(New York)
There is big risk to the muni bond market that you are probably aren’t thinking about. That risk is how increasingly frequent weather-related calamities are befalling US cities as the climate changes. The market is already starting to price these risks, and according to BlackRock, many current muni bond issuers could see 1% knocked of their economic output. According to the head of muni bonds at BNY Mellon, “The risk has been identified by market participants … Looking at the severity of storms picking up . . . it will start to be factored in”. When choosing bonds, investors need to start demanding or checking on plans from issuers. “What plans are they making? Are they hardening their infrastructure . . . are they trying to insulate central services? If they’re just stating the obvious, that’s not sufficient”, says BNY Mellon.
FINSUM: This is an important consideration for all those that hold munis. Think of the weather-related calamities that have happened lately and consider the implications (e.g. Houston).
(New York)
For around a year now, the yield curve has been scaring investors. The inversion of the curve sent a grave warning sign to the market that a recession may be on its way. Many investors fled the market for fear of a big reversal. However, as we enter 2020, the yield curve is sending a very different signal—optimism. The curve is at its steepest level since October 2018, showing investors’ increasing confidence in the US economy. One CIO described the situation this way, saying “If the stock market is right that everything is amazing, I don’t see how long rates can stay as low as they are … The stock market is rallying on hope. Hope that things will inflect higher with this trade deal and Fed accommodation”.
FINSUM: If there is one thing we have learned in the last decade, it is that the Fed does not want to over-hike on rates. Overall, we think this is a very healthy direction for yields.
(New York)
It has taken a long time for bond ETFs to begin getting even a tiny bit of the attention stock ETFs have gotten, but the trend has finally taken hold in earnest, and that s good news for investors. While active bond funds have done well in recent years (perhaps due to it being considered easier to outperform a bond index than a stock index), bond ETFs have now started to surpass them in growth. This is adding much more liquidity to bond funds, which benefits investors substantially. Both active and passive bond funds have taken in over $200 bn each in 2019.
FINSUM: While “liquidity mismatch” worries will continue to linger, the fact is that bond ETFs make a lot of sense (perhaps even more than stock ETFs?) because they circumvent minimum-buy and illiquidity issues, allowing many more people to access hard-to-reach corners of the bond market.
(New York)
Goldman put out a warning on Friday and advisors should pay attention. The bank is warning of what it calls a “baby” bear market. The focus this time is not on equities but on bonds, which have mostly been very hot this year. Goldman thinks that Treasury yields are going to take a hit in 2020, falling back to around 2.25% on the ten-year. That is a pretty large move from the 1.7% level seen today. The catch on Goldman’s call is that it doesn’t really see the move beginning until the second half of 2020, so it is a bit of a delayed bet.
FINSUM: This is quite a long-term view and in Goldman’s own words is contingent upon investors thinking the Fed might hike rates. That seems a LONG way off; at least post-2020 election we would think.
(New York)
After what was a great run for much of this year, ETFs investors are fleeing bonds. After yields fell sharply for most of 2019, investors have been stung this month as yields have shot higher. Ten-year Treasuries have gone from 1.7% to 1.9% yields, causing over half of all bonds to lose value. Investors have been pulling billions out of funds as a result. The iShares 20-year Treasury ETF has lost 7.8% since August 28th. One of the areas that has been more durable is high yield, where average prices have risen a little over 1% in the same time frame.
FINSUM: Bonds losing is a sign that investors are getting less worried about a recession, which in our view is an optimistic sign.
(New York)
Bank of America has just made a bold call on the direction of yields. The bank has sharply increased its forecasts for where bond yields will be at the end of the year. Its previous forecast for the ten-year was 1.25%, but it has just moved that up to 2%. It made similar adjustments to its forecast for German and British bonds. “Relative to our more pessimistic revision in August, the US and China are working to de-escalate trade tensions, no-deal Brexit risks have been banished for now, global data have started to stabilize, and central banks have shifted from dovish to neutral policy stances”.
FINSUM: Based on the change in mood amongst investors and central banks, this forecasted change makes total sense to us.
(New York)
For many months there has been a great deal of fear about the threat of BBB bonds falling into the “junk” category. The whole fear is based on the idea that as the economy slows, this huge group of companies would get downgraded and there would be forced divestiture, sending bond prices strongly lower. However, the opposite has happened. Over the last few months, BBB bonds done nothing but strengthen. In fact, the spread between BBBs and Treasuries just hit a 52-week low, showing investors renewed faith in what is the largest segment of corporate bonds.
FINSUM: Unsurprisingly, the price growth has led to a bunch of new issuance. It is important to remember that though prices have risen, the risk of a recession and downgrades is still very much there.
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(Washington)
The Fed finally paused. Investors were worried about it, but it happened as many expected. The Fed decided to lower rates another 25 bp yesterday, but said that for the time being, it would stop worrying about the possible trade war. Analysts interpret Powell’s statements as indicating that the Fed wants to wait to see weakness in the US consumer before undertaking any more rate cuts.
FINSUM: Some are perplexed by this pause because none of the three main things the Fed is worried about have actually improved.
(Los Angeles)
For many years Pimco was the undisputed leader in bonds. While that reputation may now be arguable given Bill Gross’ departure, Pimco is still undoubtedly highly respected. Therefore, their warning this week is worrying. The firm says it is shunning corporate bonds because of the big risk of a quick fall in prices. The firm’s CIO, Dan Ivascyn, says “The credit sector has been well behaved but if people begin to really fear recession, we can see underperformance quickly … this is the sector most prone to overshooting on the downside”. Pimco is also worried about Treasuries as they see no further room for a rally and instead are favoring agency MBS.
FINSUM: Total debt has grown hugely and a lot of it is of borderline credit quality, so a real downturn in economic expectations could lead to a lot of selling and downgrades. We tend to agree with Pimco here.
(New York)
Probably the world’s most famous hedge fund manager, Ray Dalio, who runs the largest hedge fund in the world, has just made an interesting comment about equities. Dalio, who runs Bridgewater, says that he does not see a big bust coming in equities, just a “great sag”. Speaking about corporate debt levels and the risk of a blow up in fixed income, Dalio says “Those extremities we are reaching are not such that it is likely to have a debt crisis. But you have reached the limits of that so it creates a big sag versus a big bust”.
FINSUM: We think this is a pretty nuanced view. A big meltdown similar to 2008 does not seem likely, but a long-term growth overhang from too much debt does seem a distinct possibility.
(New York)
If you are looking for some good muni bonds to add to your portfolio, take a look at an interesting new offering from a group of US universities. Georgetown, University of Pennsylvania, and Rutgers have all issued “century” muni bonds, and they may prove a good investment. Rutgers’, as an example, yields 3.9% and has an A+ rating, a significant spread to the typical 3.2% yield on other long-term muni bonds. Even BBB bonds, which are in a tenuous position, are only yielding 3.2%.
FINSUM: The yield is great, but your great grandchildren will be getting the principal back!