Where to turn amid bond market chaos?

By Jeffrey R. Kosnett
Posted on May 13, 2020

I won’t mince words: “Lower for longer,” my overriding view of fixed-income yields, is trending toward “lowest imaginable.” Expect the imminent return of zero, or near-zero, rates on money market funds, three- and six-month certificates of deposit (CDs) and bank deposits.

Bonds with 4% and 5% coupons will be called in bunches by their issuers. Mortgage refis will cut the payouts from Ginnie Mae funds. More dividend erosion is in store for short- and intermediate-term bond funds.

Is the slide in yields a disaster for you and me? Not immediately, if you own, directly or through funds, noncallable investment-grade bonds or government and municipal bonds with decent coupons and many years to maturity.

Credit is sound — outside of retail and oil and gas, and maybe airlines — so 98% of all bonds will pay on schedule even if economic growth hibernates this summer.

Interest rate fears

But the daily pressure for interest rates to plunge further comes from many sides. And that’s what frightens me.

Start with the stock market: It’s an impulsive polling booth where orderly price declines due to tactical selling are supercharged by technical scourges such as rapid-fire hedge-fund trading, margin calls and impaired liquidity in options and futures.

The trillions of dollars escaping stocks are hyper-inflating bond prices (that means lower yields, which move in the opposite direction). Meanwhile, politicians and central bankers imagine that interest rate cuts can repel economic havoc. That’s questionable.

The real nightmare scenario is that you lock your money in a low-yield prison just in time for normalcy to return to the financial markets. At some point, the interest-rate curve will trace a V — because if 10-year Treasury yields can travel from 1.5 to 0.5% in a fortnight, the reverse is also possible. A reversal could start as soon as the health headlines are less dire and stocks rally for longer than a few hours.

Fixed-income markets will then confront a simultaneous buying strike and profit-taking spree. Positive total returns — such as the 2.4% delivered year to date through March 13 by the Bloomberg Barclays Aggregate Bond index — could flip to losses. I would consider exiting long-term Treasuries rather than blindly using them as a haven from chaos elsewhere.

Consider munis

Where would I look instead? Municipal bonds are mostly keeping their distance from this chaos. And the ratio of tax-free to taxable yields is again favorable.

Consider Vanguard Tax-Exempt ETF (symbol VTEB, $52). It yields 1.2%, equivalent to 2% for some taxpayers.

My favorite closed-end tax-exempt fund, BNY Mellon Muni Bond Infrastructure (DMB, $12), pays a secure monthly dividend and yields an annualized 5.3%. After briefly trading above its net asset value, the fund is discounted again.

Actively managed, go-anywhere bond funds are made for challenging times, including FPA New Income (FPNIX), Metropolitan West Flexible Income (MWFSX), Osterweis Total Return (OSTRX), PGIM Total Return (PDBAX) and RiverNorth DoubleLine Strategic Income (RNDLX). Their net asset values won’t fall apart if Treasury yields bounce. Nor will the payouts crater — though I grant they may shrink a little — because of their mix of assets.

Well-screened high-yield bonds and preferred stocks are worth a look. AT&T’s 4.75% series C preferreds, issued at $25 in February, are a good value at $23, for a yield to call in 2025 of 5.8%. A junk fund with low exposure to energy — think TCW High Yield (TGHYX), yielding 3.3% — is fine.

Don’t get too fearful. Fear rarely pays.