By Gary Stringer, Kim Escue, and Chad Keller
One of the more challenging areas of the financial market over the past decade has been fixed income. If you thought investing for yield was hard before, the year 2020 was a reminder that it can always get trickier. Many financial advisor and fixed income investors are wondering where to go next to find yield in a landscape rife with uncertainty around both credit risk and interest rate risk. We have seen huge swings in the 10-year U.S. Treasury as the U.S. Federal Reserve’s promise to backstop just about everything imaginable has left many investors paralyzed as the 10-year U.S. Treasury dropped to its lowest level in history. Now that we have made history, it’s time to learn from it and try to decipher what opportunity it may present. Extreme events in the financial markets often provide opportunities, so we think it’s prudent to always be on the lookout for them.
The first lesson we learned was that despite coming into the year with an already challenging rate environment, rates did go lower. It’s an understatement to say that the current rate environment resulted from extenuating circumstances that no one could have predicted, but that’s part and parcel for investing. With massive stimulus and rates cut to the bone, the 10-year cratered to a historical low of almost 0.50%. While the likelihood of rates declining further seems improbable, never say never. At this point, we think the probability has now shifted to rising rates over the next two years. As the economy recovers, our work suggests the 10-year yield will rise and we could see it somewhere north of 1.25%. In this scenario, one might avoid stretching for yield by moving out on the curve as longer duration bonds should get hit worse in a rising rate environment. We also think investors should consider more active bond management where duration and credit risk are managed by professionals rather than simply invest in passive fixed income products.
Content continues below advertisement
Secondly, fixed income investors that reached into the equity income bucket thinking the yield was attractive and safe were half right. The yields were attractive, but the market reminded those investors that they still owned equities with equity risk and dividends are not guaranteed. Additionally, some investors learned that sector concentration in dividend strategies really matters as sectors like energy and utilities broadly corrected and continue to lag.
So, what is the likelihood of these areas declining further and is there an opportunity? We think active management in the equity income space can make all the difference. There are areas in the equity income space that could be challenging for some time while there are also areas that make more sense and have attractive valuations, such as financials. Looking at history, the last time the U.S. Treasury yield increased by as much or more than we expect over a short period of time was in between July 2016 and March 2017. Over those 9 months, the 10-year yield rose from roughly 1.4% to 2.4%. Those rising rates were very positive for financials and the broad sector outperformed the S&P 500 Index during the period.
Finally, despite the U.S. Federal Reserve’s (“the Fed”) history of showing up empty handed and late to the party, the Fed now seems willing to not only do more than previously thought, but also much faster when faced with a crisis. The probability for an accommodative Fed and easy money for a long time are extremely high. Current health crisis notwithstanding, the $5 trillion on the U.S. Federal Reserve’s balance sheet and their ability and willingness to keep short-term rates low is not something to bet against. Simply stated, don’t fight the Fed.
So, what is the likelihood of the Fed changing course and is there an opportunity? Our work suggests there isn’t a high probability of the Fed changing course any time soon. They have commented that rates will be low for as long as it takes to get the economy back on track. They have also shifted from a fixed to an average inflation target, which suggests that inflation could run hot before any action would be taken. Once the U.S. and other countries get a handle on the health related crises over the next 12 to 18 months, and all this liquidity starts to penetrate and get absorbed into the global marketplace, we could see both inflation and business investment making equities very attractive.
In conclusion, there is no replacement for experience. As the saying goes “history doesn’t repeat itself, but it does rhyme.” This is as true today as it ever was. Obviously, the market has inherent risks and there are certainly still many unknowns when it comes to this current crisis. However, the key to investing is simply trying to stack the odds in your favor.
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management, LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.
Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.
Data is provided by various sources and prepared by Stringer Asset Management, LLC and has not been verified or audited by an independent accountant.
S&P 500 Index – This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
S&P 500 Financials Index – This Index is capitalization-weighted and is designed to measure the financial sector of the S&P 500 Index.
newETFs.io respects the hard work of others and gives all credit to the remarkable folks at ETFTrends.com. This excerpt/article was pulled from their RSS feed; click here to view the original. Please note that on occasion, the RSS feed will not have the author. When this happens this site defaults the author to "News". Make no mistake, this excerpt/article was not created by newETFs.io, it was simply shared with you.