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Bonds are the Antidote for Coronavirus

February 27, 2020

The coronavirus, known as COVID-19, continues to plague the stock markets of the world. This week, the contagion spread to the US markets, and the S&P 500 Index is now down over 4% for the year to date.

But the more globally focused companies inside the Dow Jones are driving that index down by over 6%. The Nasdaq Composite, on the other hand, is only off about 1% thanks to its broader array of companies, including domestic technology firms.

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 US Aggregate Bond Index—Source: Bloomberg Finance L.P. & Barclays

Bonds are performing for a variety of reasons.

First, US 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 US interest rates after its tightening in 2018 and its reactive easing in 2019. The US Treasury market yield curve is still not fully normalized.

US 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.

The FOMC is also ramping up its bond buying, which should work to bring shorter-term yields lower as well as longer rates.

Next is demand. Even before the COVID-19 hysteria, institutional bond investors from insurance companies to pension funds have been heavy buyers.

On the global investment front, the primary markets of Europe and Asia have negative yields for bank accounts and bonds. So, the US bond market looks very attractive to them.

And credit conditions in the US for corporations and municipalities continue to advance higher this year following the improvements from 2017-2019. This brings down yields and drives bond prices higher.

Treasuries are great, but income investors that follow my Profitable Investing recommendations can do much better.

Corporate Bonds

Start with US corporate bonds. This market is outperforming the aggregate US 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 US corporate bond market is through a closed-end fund run by BlackRock.

The BlackRock Credit Allocation Income Trust (BTZ) has a great collection of US 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.

BTZ traded off yesterday and today as some closed-end funds can do during general stock market selling. That makes it an even better buy.

It continues to outperform the US aggregate and corporate market with a return for all of 2019 to date of 34.1%. BTZ is a great buy right now for tax-free accounts.

Municipal Bonds

Now let’s talk municipal bonds, which have been a big success for the model portfolios of Profitable Investing.

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.

The arguments that I made back then haven’t changed much.

First, the US economy is growing, aiding the credit standing of municipal issuers.

Next, municipalities have been issuing fewer muni bonds as rising tax revenues have decreased their need to raise money. This means less supply in a better market.

Add in low-to-lower inflation and the big boost from the 2017 Tax Cuts & Jobs Act (TCJA) that limited state and local tax (SALT) deductions, and the demand for more tax-free income—particularly from high-tax states and localities—makes for further demand for muni bonds.

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.

All My Best,

Neil George
Editor, Income Investor’s Digest & Profitable Investing
Author, Income for Life

PS—It’s that time of year again! Our annual Diamond Club meeting is right around the corner, and I’m busy preparing to get together with my subscribers to discuss my outlook for the stock and bond markets and how to best position our portfolios for the remainder of the year.

This exclusive in-person meeting is only available for Diamond Club members. But don’t worry… If you’re not already a lifetime member of my Profitable Investing research service, there’s plenty of time to sign up and save a ton on your subscription. Click here for details.