by Nick Goetze, Raymond James
Nick Goetze discusses fixed income market conditions and offers insight for bond investors.
If we all KNEW what the markets were going to do, the investment side of life would be a breeze. We would only need one financial news channel, there would be no need for endless opinions from pundits and markets would be calm and orderly. However, we do not. An old adage goes, “When everyone agrees on where the markets are headed, watch out!” So, we attempt to balance our portfolios to be prepared for a range of outcomes.
Today, we see an inverted Treasury yield curve that is getting long in the tooth. We have been inverted for 300 days as of this publication. This inversion is both long and deep. Historically, inversions have led to an eventual recession. Pundits are debating if it is different this time but remember, while history does not often exactly repeat itself in the financial world, it almost always “rhymes.” So, if you are of the belief we are headed for a financial downturn, how and when do we prepare?
In the fixed income world, we know what the pattern is. When the Federal Reserve ends their rate hiking cycle and the yield curve inversion turns positive sloping, on average we enter a recession four months later (based on data from the last four recessions). In anticipation of the upcoming recession, yields on the longer end of the curve tend to fall. Remember the Federal Reserve controls the Fed Funds rate which is the shortest point on the curve while the long end of the curve trades on the future expectations of where the economy is going. Eventually, the Federal Reserve drops short term rates to stimulate the economy and in doing so returns the Treasury curve to its normal positively sloped shape. In this scenario, a forward-looking strategy would be to extend your current fixed income investments further out on the curve to lock in the substantial rate opportunities that are currently available before they disappear. Even though short rates are currently very attractive, the near-term reinvestment of those securities will cause you to reinvest into a lower rate world in the near future should the lower yield scenario play out. This is commonly known as reinvestment risk in the fixed income world.
Having a defined strategy using individual bonds for your fixed income allocation gives you the control to succeed regardless of what interest rates do.
Adding duration could also be beneficial to total return investors with a goal of nearer term price appreciation. One of, if not the most, negatively correlated assets to the equity market is high-duration, high-quality fixed income. If the scenario we are discussing plays out, there is an opportunity to balance an equity market pullback. If rates do decline on the long end and we eventually head into a recession, higher duration bonds will see their prices appreciate more than shorter-duration bonds.
If we only KNEW where the markets were headed. But we don’t and never have with 100% certainty. We can however compare today with the cycles of the past and prepare to take advantage without undue risk. Having a defined strategy using individual bonds for your fixed income allocation gives you the control to succeed regardless of what interest rates do. You have defined cashflow and known return of principal dates that do not change with the gyrations of the market. The current interest rates in the market are at or near peaks that we have not seen over the last 15 years. Take advantage by locking them in a defined portfolio that is custom to your objectives.
Raymond James has tremendous Fixed Income capabilities to support you through your financial advisor. Let us help you devise the right strategy for your long-term goals.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.
To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.
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