MARKETS & INVESTING
January 09, 2023
Doug Drabik, Drew O’Neil, Rob Tayloe and Josh Milrad discusses fixed income market conditions and offers insight for bond investors.
Starting a year on a positive note is quite welcoming for income buyers. Although media outlets talk endlessly about what a bad year 2022 was for investors, those investors who utilize fixed income securities primarily for principal protection not only achieved that goal (as they would regardless of where interest rates are) but reaped the benefits of locking into high levels of income not seen in years. The media tends to emphasize price because that is what drives value or total return in stocks; however, when bond prices fall, yields go up. These higher yields enthused and prodded many investors at the end of 2022 to swarm into individual bonds. Yield gratification leads the list of 2023 themes.
Since the turn of the century (23+ years), the S&P Total Return Index has averaged an annual rate of return of 6.33%. However, current fixed income market conditions provide tax-equivalent opportunities of 5.0% to 7.0%. Investors benefit two-fold: principal protection augmented with locked in higher levels of income. If investors can capitalize on growth-like returns with the fewer risks associated with high quality individual bonds, not only is it appropriate but timely as well because it goes beyond just providing principal protection.
Our next theme may seem contradictory since it is about “timing.” That is, don’t try to time the market. Fixed Income investment strategies are long term in nature and although timing appears right in the market, that is not the appeal many investors are after. Yield opportunity is ripe and historically compares well for investors. Attempting to time market entry based on Fed announcements or economic data releases may undermine the goal by adding or detracting achievable income levels (increasing investment risk) instead of implementing the yield levels in hand. When an investment goal is within reach, consummate the success.
Uncertainty dominated market sentiment for much of last year. A consequence of this uncertainty was market fluidity. The bond and stock markets both experienced significant volatility throughout the year. We anticipate continued uncertainty and market volatility for at least the first half of this year. As a result, we believe 2023 will require investors to be flexibile. By example, at different times last year, different products transferred into or out of comparable favor as demand, supply and investor expectations shifted. Corporate and municipal yield curves shifted very differently to each other as well as to the Treasury yield curve, thus, constantly changing where the greatest opportunities were. Fortunately, with custom designed individual bond portfolios, it is quite simple to flow with these changes and constantly realign strategies suitable to distinctive investor goals and specifications.
Our last theme is one of understanding risks and tradeoffs. Given obtainable high yields in high quality securities, it may be favorable to add duration – lock into these levels for longer periods of time. Although this adds market and price risk (since you are holding a bond for longer, more things can happen over longer periods of time), it also lowers near-term reinvestment risk. Investors often think that staying short is “safer” than going longer yet the reality is that it is nothing more than a call on future rates. Think of it this way. If we absolutely knew that over the next five years interest rates would fall, it would be prudent to lock into a minimum of a five year investment. Any maturity shorter than five years would require us to reinvest into a lower rate of return. These tradeoffs exist with product choice, credit quality, duration, coupon, etc.
We don’t know how long the current window of opportunity will remain intact, so we encourage you to examine the fixed income portion of your portfolio to see if you can benefit from the current interest rate environment. Contact your financial advisor and ask them for a review of your portfolio’s fixed income allocation.
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.