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Buy What the Fed is Buying

April 30, 2020

Stocks continue to get all of the attention on Wall Street. But stocks aren’t the only growth investments.

Bonds also provide plenty of opportunities for appreciation as well as ample streams of income.

The main portfolio of my Profitable Investing advisory is called the Total Return Portfolio for that reason.

I make the allocations and individual recommendations focused on generating total return, which includes capital gains and dividends. And my allocations always include bond and bond-like investments.

Bonds have a history of working for both income and growth. In the US, the Bloomberg Barclays US Aggregate Index compiles the overall US bond market. Over the trailing 20 years, it has generated a return of 174.8%.

While a little short of the S&P 500 Index’s return of 199%, it achieved that growth with a lot less drama.

Bonds vs. Stocks: US Aggregate (White) & S&P 500 (Orange) Total Return—Source: Bloomberg Finance, L.P.

That’s why I continue to recommend buying bonds and, specifically, US corporate bonds and municipal bonds. While March brought some massive upheavals to these sectors as plunging stocks brought panic selling of everything in the quest for cash, there’s a lot of value in both of these sectors.

During the past several weeks, I have been spending more attention on the credit status of companies and their stocks. But it’s good to note that the bond market has a lot more certainty in the core sectors.

Treasuries can’t default. And as for investment grade corporate bonds, since 1970 through 2016, Moody’s (MCO) states that the default rate has only been 1.74% through all of those decades. And for investment grade municipals, the default rate is a mere 0.18%.

With the market shocks and gyrations in March, the spread between municipal bonds and corporate bond yields over Treasuries has spiked. The last time we had such a spike was during the 2007-2008 financial crisis.

Yields for Municipal (White) & Treasuries (Gold) & Spread (Green)—Source: Bloomberg Finance, L.P. & Barclays

Yields for Corporates (White) & Treasuries (Gold) & Spread (Green)—Source: Bloomberg Finance, L.P. & Barclays

This means there are significant yield opportunities to buy right now. And as both municipal bond and corporate bond prices are down with the yields up, they make for great opportunities for gains as the markets further normalize.

Buy What the Fed is Buying

Through the special vehicles with credit guarantees from the Treasury, the Federal Reserve is making massive buys of US corporate and municipal bonds. It’s doing this to both stabilize the bond and credit markets now, as well as working to drive down yields and credit costs for corporations, municipalities and other debt issuers.

This means both segments and others have a major buyer that underpins prices. Just like after 2007-2008, the Fed kept the bond portfolio and reinvested maturities and interest for most of the following decade. And recently, the new and renewed buying is bulging the Fed’s portfolio to nearly $7 trillion and climbing.

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

The past has shown how corporates and munis profit with Fed actions. From the end of 2008 through the end of 2019, corporate and municipal bonds generated returns of 103.6% and 72.7%, respectively.

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

Corporate Buys

Two bond funds to buy right now include the BlackRock Credit Allocation Income Trust (BTZ) and the Vanguard Intermediate-Term Corporate Bond ETF (VCIT).

Both have impressive collections of US corporate bonds, with BlackRock actively managing the actual bonds, while Vanguard does it synthetically following the BlackRock & Barclays Index. And remember, BlackRock is under contract with the Fed to oversee bond buying.

Since late March, both have impressive performance, with VCIT at 10.3% and BTZ at 37.3%.

VCIT yields 2.9% and is a buy in a tax-free account.

BTZ is a closed-end fund and trades at a discount to net asset value (NAV) now of 6.9%, making for an even bigger bargain. Yielding 7.8%, BTZ is a buy in a tax-free account.

Municipal Buys

I also have a collection of municipal bond funds within the portfolios of Profitable Investing, including the BlackRock Municipal Income Trust II (BLE), which is at a discount to NAV. It sports a taxable equivalent yield of 8.2% and is a buy in a taxable account.

Another one of my favorite bond ETFs is the Nuveen Bloomberg Barclays Municipal Bond ETF (TFI). It yields a taxable equivalent 3.1% and tracks the leading muni index. TFI is a buy in a taxable account.

All My Best,

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

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