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Bonds, Bonds & a Preferred Investment

March 05, 2020

There are plenty of companies out there that are insulated from the ups and downs over COVID-19. But that doesn’t mean that the stocks of those companies won’t continue to get whipsawed on any given day in the market.

The antidote is to buy and own fixed income investments as a strong base for your portfolio.

Bonds, preferreds and their related funds make for solid growth opportunities and not just for interest or coupon payments. The proof comes with 2019’s results: The overall US bond market returned 8.72% for the full year. And so far this year, the same broad index of US bonds has returned 4.36%, which on an annualized equivalent basis is 27.59%.

Now, let’s look at the base of the US bond market in US Treasuries. Treasury yields are down dramatically over the past week as bond buyers keep loading up on Treasuries. And aiding the bond buying is the Federal Reserve Open Market Committee (FOMC).

US Treasury Bond Yield Curve Today (Green) & 1 Week Ago (Gold)—Source: Bloomberg Finance L.P.

The FOMC continues to buy bonds, reversing sharply the roll-off of its portfolio in Septemberwhen liquidity in one of the core markets for overnight and very short-term financing for banks known as the repurchase (REPO) market moved to crisis levels, making the Fed the go-to bank for funding.

And it continues with active buying through the most recent reports of Fed assets through last week. I project that the balance will be reported up further this week again.

Federal Reserve Total Assets—Source: Federal Reserve & Bloomberg Finance L.P.

And of course, the FOMC dropped its target range for Fed Funds by 50 basis points (one-half of one percent). Fed Funds is the market rate charged by banks to lend to one another and works to influence deposit and loan rates.

With that cut, the markets have sent bond prices up and yields much lower. As you can see in the first graph of the current and one-week Treasury yield curve, the short-end of maturities is still higher with 1-month yields at 1.00%, while 6-month yields are around 0.60%. I’m betting another 50 basis point Fed Funds cut, soon.

With or without COVID-19, the US bond market is also doing well because inflation in the US is not to be found. The core Personal Consumption Expenditure (PCE) index is running at only 1.63%. This makes bond yields all the more valuable.

And before COVID-19, the globe’s major markets continue to produce larger amounts of negative yielding bonds and negative yielding bank deposit rates.

Negative Yielding Bonds in US dollar Terms—Source: Bloomberg Finance L.P.

In just the year to date, the global market for bonds with negative yields is now at $14.58 trillion and climbing. This makes the positive-yielding US treasury bond market all the more attractiveeven with the current lower yields.

But with COVID-19, the stock and bond markets are addressing two major threats to the globe’s economies: Supply of good and servicesparticularly goodshave been hindered with the isolation of folks in response to the virus. This is impacting the already sluggish or recessionary economies beyond the US and will show up in lower US gross domestic product (GDP) for the first quarter at least and potentially into the second quarter.

Demand is also being hindered as people outside the US have been hunkering down and not going out to spend. And while this hasn’t had as much of an impact in the US, the threat is very much there.

This will weigh on not just the current quarter’s sales and earnings for the stocks inside the US market but more importantly, the forward expectations in the subsequent quarters for the rest of 2020.

As these numbers drop, so too will be the attraction to buy stocks. In turn, that will drive up the desire for investors to own more bonds and other fixed income investments.

 More Yield Still Awaits

I have plenty of income investment recommendations in Profitable Investing and inside the Income Investor’s Digest over the past two years, including a series of US bond investments in last week’s Digest.

But today, I have some alternativesstarting with preferred stocks. Preferred stocks are really another form of corporate bonds that typically provide a fixed dividend that looks and feels like bond coupon interest payments. And preferreds tend to trade with less volume than other fixed income investments, so yield opportunities can be ample.

One of the easiest ways to buy a great collection of preferred stocks is in the iShares Preferred and Income Securities ETF (PFF). The ETF has a great synthetic allocation to good preferreds from US companies in the US market or related offshore markets.

PFF pays a monthly distribution currently running at 16.03 cents per share for a yield of 5.17%well above US Treasury yields.

PFF has generated a return for the trailing 12 months of 8.20%. But the real attraction is that since it trades like a stock, PFF sold off last week needlessly and now it’s moving back up. This means it’s a bargain.

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.