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Cash in on Lower Rates with High Yield at a Discount

August 08, 2019

US inflation is low and shows all indications of remaining so. And I’m looking for the Federal Reserve’s Open Market Committee (FOMC) to make further cuts in its three remaining meetings this year in addition to the other steps it has taken to guide more liquidity and to affect market interest rates.

US Core Personal Consumption Expenditure Index (PCE)—Source: Bloomberg Finance, L.P.

Meanwhile, many major economies are in worse shape. Inflation conditions in much of the European Union (EU) and in Japan are even lower. And the markets are driving interest rates into negative territory, meaning depositors pay banks to hold cash.

Bonds are increasingly providing negative yields, as non-US bond investors are so desperate that they’re effectively paying to own bonds. The total amount of negative yielding bonds is now at $15.62 trillion.

Amount of Negative Yielding Bonds Around the Globe—Source: Bloomberg Finance, L.P. & Barclays

Negative bond yields are becoming more of the norm in several major bond markets, particularly for government bonds.

Negative yields occur when coupon rates (stated interest rates) are issued at low or near-zero rates. Then the markets at auction and in the secondary market bid the bonds to prices above par (100), which brings the yields below zero.

The reason behind negative yields is that inflation becomes low or non-existent. Even bank deposits can be negative, meaning that depositors pay to park cash. And with the European Central Bank (ECB) offering negative interest rate loans, it only exacerbates the market condition in the hope of stimulating the economy and inflation.

In the US bond markets, yields are still positive, but they’re falling. And falling yields mean bond prices are rising. This has been working well for many of the bond holdings inside my Profitable Investing advisory, from individual minibonds to bond funds and ETFs.

Credit Where Credit is Due

The key to investing in the US bond market right now is to understand that lower-credit-rated bonds are like undervalued stocks. The market is mispricing the bonds much like it underprices stocks of improving companies. But it isn’t just about buying lower-grade bonds… just like it never works to simply buy stocks of beaten-down companies.

It takes work to look at the underlying companies behind the bonds. What are their true capabilities to service and pay off their debts? What are the risks that they could face in coming months and years? This is the same work that I do for stocks that I recommend in the model portfolios of Profitable Investing.

And it’s that work that’s led me to a great play on the US corporate bond market. It’s a closed-end bond fund paying a current yield of 6.00%, and it’s currently priced at a discount to its bond holdings, or net asset value (NAV), by 9.09%.

That means you get high-yielding corporate bonds at a big discount.

As you can see in the chart below, over the past three years alone, higher-yielding corporate bonds have continued to outperform the overall bond market of the US.

Bloomberg Barclays US Corporate High Yield (White) & US Aggregate Bond (Orange) Indexes Total Return—Source: Bloomberg Finance, L.P.

Buy the BlackRock Credit Allocation Income Trust (BTZ). As mentioned, it’s a closed-end fund run by one of the biggest and best asset managers, BlackRock (BLK), which I also recommend in Profitable Investing.

Its largest allocations are to BBB-rated bonds, which are at the bottom of the investment grade—bringing opportunity for appreciation while controlling risk. And it also has a series of bonds just above and just below that rating tier, again delivering higher relative yields while limiting credit risk.

And despite its impressive performance of 39.78% over the past five years, the fund trades at a discount to its NAV.

BlackRock Credit Allocation Income Trust (BTZ) Stock Price (White) vs. Portfolio NAV Values (Blue) and Discount Margin (Red)—Source: Bloomberg Finance, L.P.

This discount has been narrowing sharply since December of 2018, which means a higher stock price for BTZ even if its portfolio remains flat, which is doubtful.

What’s more, there’s an activist investor who’s taken a large stake in BTZ and is suing BlackRock to change the terms for board-election procedures. If he gains seats, that discount will close even faster, boosting the stock price.

Buy BlackRock Credit Allocation Income Trust (BTZ), ideally in a tax-free account, for growth and higher income.

All My Best,

Neil George
Editor, Dividend Digest & Profitable Investing

PS—Now that I’ve presented one of my favorite ways to continue to cash in on lower interest rates for more income and gains, be sure to check out my Profitable Investing advisory for more of my market research and recommendations for further, safer growth and bigger, more reliable income.

And if you find yourself in San Francisco on August 15-17, please join me at the MoneyShow investment conference where I’ll be presenting my economic and market analysis and my latest investment themes and recommendations. Click here for more information.