As the stock market drops, bonds are racing higher. Add in a likely interest rate cut, and bonds look like a no-brainer today
Last week, stocks suffered their biggest weekly loss since 2008.
Snowballing investor unease about the economic fallout from the coronavirus epidemic has resulted in widespread selling, pushing the S&P 500 down 15% from February highs … and at a blistering pace. In fact, it took just six trading sessions for the S&P to fall into correction territory.
(Note: Matt McCall recorded a fantastic podcast on Friday which dives into this market correction, why it’s a buying opportunity, and why the financial media is in the business of selling fear. It’s a must-listen. More details at the end of today’s Digest.)
Meanwhile, the yield on the 10-year U.S. Treasury note dropped to a new all-time low Friday (hitting 1.157%) as frightened investors stampeded into bonds. And as I write on Monday morning, it’s set a new record, hitting 1.03%.
Global investors even bid up negative-yielding bonds last week. For example, the German 10-year yield fell from negative 0.54% to negative 0.592%.
Frankly, fear is spreading faster than the virus itself.
From an investment perspective, this fear boils down to reduced earnings. Goldman Sachs reports it’s now expecting 0% earnings growth in 2020.
Given how much uncertainty surrounds the coronavirus — namely how far it will spread, and how long its effects will impact corporate earnings — just “how low we’ll go” with earnings isn’t clear. And it’s that uncertainty itself that is exacerbating the fear.
Simply put, there are some big unknowns suddenly facing investors. But there is one variable that investors are beginning to bet on with far greater certainty … lower rates.
***The reduced earnings outlook is putting pressure on the Fed to cut rates
Last Friday, St. Louis Fed President James Bullard said the coronavirus would have to hit ordinary-flu levels before he would consider cutting rates.
The market doesn’t agree.
The CME Group publishes its FedWatch Tool, which tracks the probability of interest rate moves from the Fed.
On Friday, February 21st, investors placed a 90% chance on the likelihood that in the Fed’s March meeting, policymakers would hold rates steady — meaning they would remain in the 1.50% — 1.75% range. Here’s a screenshot from that point in time.
And where are the probabilities today?
Investors are putting 0% odds — literally no chance — that the Fed holds rates steady in March.
As you can see below, they’re putting 100% odds on — not just a quarter-point cut — but a half-point cut at the March 18th meeting.
If we look further out to the December Fed meeting, the highest probability bet — now 38% — is that target rates will be all the down to a range of 0.50% – 0.75%.
So, what does this mean?
Bond prices are probably going higher.
***Why bonds are actually attractive today, despite low yields
The Fed is under immense pressure to cut rates, as we just saw above with the FedWatch tool.
How much they cut and when isn’t certain (despite the 100% odds in the FedWatch Tool), but we can say with reasonable assurance, some sort of cut is coming.
The most direct way to play an interest rate cut is with bonds — they’re sensitive to rates and similar macroeconomic influences.
And if the Fed’s target rate is going down, we’ll likely also see downward pressure on sovereign bonds and bills and corporate debt.
For more on this, let’s turn to expert income investor, Neil George, editor of Profitable Investing.
Neil began his update last Thursday by noting the losses in the stock markets, then providing an overview on bonds:
At the same time, US bonds continue to perform like they did in 2019. And for the US market as a whole, bonds are up year to date by 3.1%.
Bloomberg Barclays U.S. Aggregate Bond Index –Source: Bloomberg Finance L.P. & Barclays
Bonds are performing for a variety of reasons.
First, U.S. inflation, as measured by the Fed’s preferred index — the Personal Consumption Expenditure Index (PCE) — is at a mere 1.58%. This is well below the Fed’s target level of over 2%.
And the Federal Open Market Committee (FOMC) is still working to fix U.S. interest rates after its tightening in 2018 and its reactive easing in 2019. The U.S. Treasury market yield curve is still not fully normalized.
U.S. Treasury Curve — Source: Bloomberg Finance L.P.
The short end of the curve — meaning current yields at each maturity — is still not down. This should be fixed by further FOMC easing in its target range with two rate cuts sooner rather than later.
If you’re looking for a way to play Treasuries, consider TLT — that’s the iShares Barclays 20 Year Treasury Bond fund.
Below, you can see the massive divergence in the fate’s of TLT versus the S&P 500 here in 2020. But what’s interesting to note is that TLT was climbing right alongside the S&P early in January.
To put it simply, bonds are working in all sorts of market conditions.
If we zero in on what’s happened in just the last two and a half weeks, the disparity is even more glaring.
***While TLT and U.S. debt is likely to treat your money well, Neil likes other plays better
Back to Neil:
Start with U.S. corporate bonds. This market is outperforming the aggregate U.S. bond market with a year-to-date gain running at 3.5%. In 2019, corporates finished up 14.5%.
One of the best ways to buy into the U.S. corporate bond market is through a closed-end fund run by BlackRock.
The BlackRock Credit Allocation Income Trust (BTZ) has a great collection of U.S. bonds that are generating a yield for shareholders of 7.2%.
And it gets better: You can buy this fund at an 8.9% discount to the net asset value of the bonds inside the fund. That’s a huge deal today.
***But this isn’t the only bond-play Neil recommends right now
He’s also eyeing the municipal sector. For any readers newer to bonds, municipal bonds (or “munis”) are bonds issued by local governments — cities, states, or counties — rather than our federal government or corporations.
One of the biggest draws of munis is that they offer a huge tax advantage. In general, the interest investors receive from munis are exempt from federal taxes and sometimes even state and local taxes. Depending on your tax bracket and your investment amount, this can be a substantial benefit.
Back to Neil:
In early 2018, I added three closed-end municipal bond funds, including the BlackRock Municipal Income Trust II (BLE), the Nuveen AMT-Free Municipal Credit Income Fund (NVG) and the Nuveen Municipal Credit Income Fund (NZF).
Since then, the three funds have generated an average return of 30%. That compares very well to the general municipal market return of 12.9%.
BlackRock Municipal (BLE, White), Nuveen AMT-Free (NVG, Orange) & Nuveen Municipal (NZF, Gold) Total Return — Source: Bloomberg Finance L.P.
Neil tells us that the arguments he made in favor of muni bonds back then haven’t changed much …
We still have a growing U.S. economy, municipalities have been issuing fewer muni bonds so supply is in better shape, and finally, low-to-lower inflation and the big boost from the 2017 Tax Cuts & Jobs Act that limited state and local tax (SALT) deductions is all leading toward increased demand for munis.
So, which muni bond fund does Neil like the best?
The best one to buy today is NZF. It holds great muni bonds with a huge taxable equivalent yield of 6.9%.
And like the BlackRock Corporate fund, the Nuveen fund is at a big 4.6% discount to NAV. NZF is another strong buy, ideally for taxable accounts.
If you’re needing great cash-generating income ideas, or simply want help navigating the bond and income markets, there’s no one better than Neil. Click here to learn more about joining Neil in his Profitable Investing newsletter.
***Nervous about this correction? Listen to Matt McCall’s latest podcast
The markets are rallying on Monday as I write, but the recent losses have rattled many investors. If you’re among them, please listen to Matt McCall’s latest podcast from this past Friday.
Matt tells us that the heavy selling is the result of panic and fear surrounding the coronavirus. And because the financial media is in the business of generating ad revenue, we’ve seen extremely misleading headlines that stoke that panic and fear. When investors are scared and uncertain about the future, they sell. The problem is, they should be buying — or at the very least holding steady.
Matt breaks down all the details, even referencing specific sectors and stocks that look primed to bounce back after fears subside. It’s a must-listen episode.
Click here to check out the episode on Matt’s YouTube channel. I highly-recommend you subscribe. That way you’ll get up-to-the-minute alerts when Matt posts new videos.
Have a good evening,