Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
Many investors buy individual bonds as a means to preserve their wealth. They can serve as a method to balance growth assets (such as stocks). We’ve talked a lot about how interest rates are currently elevated and how buying individual bonds provides investors with relatively high levels of income and potential cash flow - levels not readily obtainable over the last 15 years. Now if that is not enough, in addition to the current income benefits, market conditions may be favorable for positive total returns. Total returns take into consideration the income as well as the price appreciation/depreciation on an asset. Many investors buy individual bonds to hold to maturity which removes price effects on return. Since most pundits and investors are anticipating interest rates dropping, price appreciation would be a positive consequence of falling interest rates for total return investors.
All of this creates a valid awareness to lock into these yields for longer. Increasing duration is a compelling long-term strategy. The choice of individual bonds can be optimized by viewing what the various product curves offer. When the media talks about the “curve,” it typically means the Treasury curve (purple line). The corporate (blue) and municipal (black) bond curves maintain very different shapes and can help guide investors to bonds that will optimize returns.
This graph contains only high-quality investment-grade level credits. The corporate curve is fairly flat yet elevated. It creates much opportunity in the short to intermediate maturity range. The municipal curve is the steepest most upward-sloping of the curves, but very expensive on the short-to-intermediate part of the curve. The greatest value for municipals is in the 15-30 year range. It also is based on investors in the highest federal tax bracket where the tax-free income benefits realized are at their greatest. If you are an investor in any of the lower federal tax brackets, the after-tax equivalent yields would be lower than depicted.
Treasuries are federally taxed and state tax-exempt, creating an edge for investors seeking the safest credits and/or short liquidity positions. It is important to realize that these curves move in a very fluid fashion, meaning they can shift quickly depending on economic data releases, sentiment changes or supply/demand shifts. Let your financial advisor help guide you to the appropriate high-quality opportunity that best aligns with your specific goals and risk profile.
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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