Finding a yield in a bond market pegged at near zero interest rates is a daunting challenge for investors, made even more difficult by the latest rates and economic projections from the Federal Reserve.
Median expectations from its Federal Open Market Decision-Making Committee indicate that the central bank will not raise short-term rates until 2024 unless labor market conditions improve significantly and inflation exceeds 2% for a while to reach an average of 2% over the long term.
Investors should choose their bonds carefully and possibly consider income alternatives, according to presenters at Morningstar’s annual virtual conference, to be held Wednesday and Thursday.
In the US corporate bond market, however, yields remain relatively high compared to bonds from EU countries, the UK and Japan, said Mohit Mittal, managing director and multi-sector portfolio manager at Pimco. “There is still value on a relative basis” and “spreads have the potential to narrow over the next 12-24 months,” which would help push prices up, Mittal said.
But he warns that “the selection of sectors and issues” will be key. He does not expect a general rally.
Rick Rieder, BMissRock’s Director of Global Fixed Income Investments warns that there is more risk in the bond market today due to leverage, which has increased, and assets riskier than inflation, the traditional bugaboo of bonds.
An aging population, coupled with the long-term economic effects of the COVID-19 pandemic, will dampen inflation and inflation expectations.
“I’m not worried about inflation but… if people think there will be more inflation that could affect investments,” Rieder said. He and Anne Mathias, senior strategist for Vanguard and a member of the firm’s Fixed Income group, both see a role for inflation-shielding assets in investors’ portfolios.
Inflation protection, at current values, “is low cost insurance for a portfolio,” Mathias said.
The two also agreed that stock picking is essential in today’s bond market. “You don’t get paid for the beta,” Mathias said. “Take a close look at lower quality bonds and middle to lower high yield bonds.”
“Do the research, be really thoughtful,” Rieder said. He prefers to buy the BBB-rated debt of a health care company rather than the investment-grade debt of an oil company. “It all depends on the individual sectors.”
Rieder also recommended that income-seeking investors look at dividends from stocks of “really stable companies,” like Apple and Microsoft, rather than interest payments on corporate bonds.
He also likes gold and “tailor-made real estate opportunities” if investors do the research and are “really thoughtful”.
When asked if the traditional 60/40 portfolio of stocks and bonds still makes sense, Reider said that “the philosophy is good, but having more stocks makes more sense.”
Rieder and Mathias both agree with Fed Chairman Jerome Powell that more fiscal stimulus is needed to support the U.S. economy and its citizens.
“If we don’t see further stimulus… we could see significant spillovers to consumer spending,” Mathias said, adding that the service sector has yet to recover.
More economic relief will mean more debt, but the U.S. economy can handle it, Rieder said. “As long as the Fed keeps rates low and the dollar remains a reserve currency, there is room to grow,” Rieder said, providing funds to service that debt. He would like the Fed to buy more Treasuries to support the dollar.
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