with most usa interest rates now below the current rate of inflation, ie. negative real yields, i know you often speak of what the text book says, does it say anything about what is the usual best of action in this situation of negative real yields? In particular as it relates to income. Do you go with shorter maturities? Longer? Shun utilities? Overweight gold/commodities etc.
There is a lot there to try to work through. I may have been interviewed on Monday about this topic (not sure if the brevity of the email exchange constitutes an interview) and so I'll expand on those answers.
The current state of yields is problematic if you have cash earmarked for fixed income, as I do as a couple client holdings have matured or been called away. Locking in less than 4% for five or ten years seems like a very bad idea (I am not really looking to buy fixed income for a trade). The short version of this post would simply be that I think the best thing for most folks is to just be patient.
I think it is unlikely that yields stay unacceptably low for a long time but I have to say that Nicole Elliott's warning notwithstanding I did not expect the ten year to go so low in yield. A few years ago yields were too low, I waited, and eventually there was a window for a few months where two year treasuries yielded 5-5.25% and so I was lucky to pick up some yield then. Yields will go up at some point.
To the reader's question of shorter maturities, the two year is yielding about 2% and the five year is a little under 3%. Assuming you are not looking for a trade do you feel compelled to lock in those kinds of yields? You are probably getting better in your money market. So, again, just wait.
You are probably aware that parts of the muni market have been yielding more than the treasury market, not doing the calculation for your tax rate but straight up yielding more (some of them). That is compelling in a way for taxable accounts but there is some sort of message there. If some issues have problems keeping their AAA rating as a function of what happens with the insurers (I am aware of the recent news but nothing would shock me) they could be a tough hold.
Obviously a rating downgrade due to losing insurance won't make the issue any more likely to default but could do some nasty things to the price between now and maturity.
The reader asks about shunning utilities. I would not shun them, no. Generally they held up much better than the market during the first couple of weeks in January and generally been market performers for the last three months but the yield has obviously been better. Bespoke had a table of average returns sector by sector during bear markets and utilities dropped what I believe was about 21-22% versus about 30% for the SPX. However when yields start to go back it makes sense to expect utilities to lag and there is some history to support this.
I would avoid heavy closed end fund exposure here. I'm not a fan of heavy exposure to CEFs in general but when rates do go up some CEFs will get pasted. Owning a couple of CEFs is ok if that happens but if you go heavy you will very likely have some ugly results where you were expecting stability.
What about floating rate funds you may ask? Sometimes they work as advertised and sometimes they don't. You are relying on the market to not create a wider discount and the market does not always oblige.
One area where I have had some luck is with foreign bonds which I have written about before. These are tough to access due to order size restrictions but the liquidity for foreign sovereign debt seems to be pretty good. Within my ownership universe is two year paper (a little shorter than that now) from Norway, Australia and Great Britain.
Each of the countries are different and so the blend makes for good diversification, IMO. GB is struggling but the yield is pretty good, Oz is a high yielding commodity currency with deficits and Norway is a commodity currency with surpluses (my YTM here is in the mid fours and the currency gain has been huge since I bought).
I'm not hoping for a lot from the currency exposure but the yield is better. If you can find exposure it might be a good thing for a small portion but again going heavy in CEFs in this space has the same problems.The WisdomTree currency ETFs could solve the problem as I believe they will hold short term debt from the underlying countries so hopefully they go ahead and list them all, the funds are successful and then they expand the product line.
Lastly a link. Mike Shedlock had a great post a couple of months ago that will be very helpful.
Last night as I watched some of the Hokies smoking of BC on the U I noticed that Adrian Branch was doing the color commentary. Wow that is a name from the wayback machine. He was something at Maryland in the mid 1980s. I tried to find a picture of him from his time with the Geelong Supercats in Australia but no such luck.
16 comments:
I understand and agree with you on staying with the shortest maturities, but if I could be in a money market or a bond index like AGG, what do you expect will do better over the next year or so? The way I see it, is that MM will continue to fall to lower returns but the AGG bond index will be able to reinvest distributions and should have a positive returm and higher than a money market. Is that the way you see it roger?
"Lastly a link. Mike Shedlock had a great post a couple of months ago that will be very helpful".
Interesting article but shouldn't stagflation be another senario and how that should be addressed?
the yield for any fixed income ETF fluctuates with the market. if the ten year yeild drops to 2% any ten year ETF will yield about the same.
i may not be reading you correctly but i think you are assuming constant yield? if so, that has not been the case in the bond market and the ETFs' yields move with the market.
Ron, the short answer is yes stagflation should be addressed. my short solution would be gold and in countries not stagflating.
"i may not be reading you correctly but i think you are assuming constant yield? if so, that has not been the case in the bond market and the ETFs' yields move with the market"
No not constant yield, but the dropping yield would be slower with the ETF than with the MM, correct? I guess I am not correct saying the reinvested dividends would help the return but would be higher yield than MM.
Short term bonds have been a good performing asset class, since the markets peak in October; i.e. BSV and SHY are up 4% over the period, while also yielding 4% along the way. I have moved this asset class into muni's, in the current environment, though.
AGG has an avg maturity of 7.04 years and an avg duration of 4.69. would you want individual issues with those characteristics?
if yes then AGG is only a little different.
if you do not want individual issues like that then agg does not make sense either.
Roy, careful with that 4%, is that looking back? I suspect that looking forward it is lower than that??
This is just a fabulous subject, Roger. Thanks for addressing it.
I've taken on some exchange-traded debt that, so far, has treated me very well. Here are three worth doing DD on, IMHO--GEJ, ATT, and NRN. All yield north of 6% and have investment grade ratings. I'm comfortable with them at least until the Fed is forced to start tightening again, at which point they could be a trade. Beware the thin volume. More at dividendyieldhunter.com.
Right - I don't think anyone is expecting 4% going forward (yield or capital appreciation - heh), thus the rotation of the asset class into muni's which still offer a capital appreciation story on several different levels (monoline bailout, higher future tax rates). Nothing is without risk, however, as states are sure to struggle over declining revenues for the foreseeable future. In fact, Arizona looks to be particularly hard hit, as their building boom goes bust.
anon, thanks for the URL
Roy right about AZ. thank goodness the missus and i loaded up on whiskey, jerkey and shells in the fall to carry us through.
Thanks for shedding more light, Roger. I recently
bought PRPFX, which holds about 25% equally in
Gld&Slv, T-bills, Swiss Francs, and aggressive growth
companies. It has an impressive track record over
the past 5-10 years although the yield is <1%.
It seems to be the type of fund that would be
resistant to recession and stagflation.
If there are similar ETF's I would like to know about
them, since this fund charges about 1.2% expense fee.
Thanks,
Scoot
i am not aware of an an ETF that is similar to the permanent portfolio but there could be a CEF that I do not know about.
the strategy could be mostly replicated with a few ETFs save for the coins which one would need PM ETFs in lieu of.
Roger,
As usual your ideas are very good, but I would like to address something I have mentioned before - expenses. Anytime a change is made in a portfolio, it incurs a cost. My question is: What is cost effective in a very volatile market? As a portfolio professional you ably explain the various possibilities. As a private investor, I have to make choices. My choices have normally been to trade as less as possible and trying to maximize dividend
and interest income.
Bernie
Bernie transaction cost matter, are not my top priority and as you have read this site for a while know I average 3-5 trades per quarter.
if you can live with the idea that you can reduce volatility of the bottom line number and that the actual components could be very volatile (this is something people learn, it is not a natural thing) then the various inverse products can go a long way to altering bottom line behavior with just one trade or simply allow for few trades. plenty of stocks in my ownership universe are down quite a bit but the double short has worked to offset a reasonable chunk. had i gone heavier i might be exactly breakeven on the bottom line.
"AGG has an avg maturity of 7.04 years and an avg duration of 4.69. would you want individual issues with those characteristics"?
In a lowering interest rate environment, yes, I think it would do better than a money market with a 60 day avg maturity over the next year and longer. Any agreement?
Roger,
As always, great stuff, but something I'd like to comment on. I take it from some of your more recent comments that you're not a huge fan of CEFs, but I'd like to differ, if I may.
If a person is approaching retirement age AND is looking to construct a portfolio to generate an income stream, I think there's a strong case to be made for CEF exposure.
First, many pay a dividend/distribution on a monthly basis, which is handy if one plans to make monthly withdrawals for living expenses. If the "plan" is to use only interest/dividends, leaving capital intact, the spread between share price and NAV should be a non-issue.
Secondly, as with a mutual fund, DD is in order. Personally, I prefer to NOT hold a fund with less than a 5 year track record, unless I see that the current management has done well somewhere else, running a similar type fund. As long as the dividend/distribution is "safe", I don't care too much about the price/NAV differential, other than to pick purchase points to enter or add to a position (try to get the largest discount to NAV as possible).
ETFconnect is a great source of stats on CEFs and ETFs.
Keep up the good work!
Jan
Jan
your point is reasonable but i immediately think of a theory versus reality dilemma that would take in most people--probably me included.
you build a portfolio of CEFs its diversified, the leverage is not crazy and any other positive you can come up with.
Then along comes a crisis that is somehow different yet the same that takes down many of the funds 15% in very short order and the nature of the crisis is such that dividend cuts abound. Realizing that the div is now less and that because it is a fund there is no par value that it has to come back to you do some selling and then they do snap back or you hold one and they go down another 5%.
This sort of thing has happened before and I know from emails and comments the canadian trust meltdown the "taking the dividend leaving the capital in tact" aspect crumbles a bit.
maybe not for you but that is how I see it. hope you take that constructively.
Post a Comment