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Better than Stocks with Added Protection

August 20, 2020

A lot has been said about the S&P 500 Index hitting a profitable total return year to date. But like all indexes, it’s always changing in membership and weightings.

In particular, the S&P has become a lot heavier in technology. Facebook (FB), Amazon (AMZN), Apple (AAPL), Microsoft (MSFT) and Alphabet (GOOGL) are the heavies for the S&P and represent 22% of the index, up from 16% in 2009.

Including the rest of their information technology peers, they make up 28% of the S&P 500.

The rest of the 505 stocks that make up the index have not all been as successful. The unweighted S&P 500 is still down 3.6% year to date.

S&P 500 (SPX, White) & Unweighted S&P 500 (SPW, Blue) Indexes Normalized—Source: Bloomberg Finance, L.P. 

I have shown this comparison now and again inside my Profitable Investing service when the stock market appeared to be getting a bit ahead of itself from the broader collection of stocks.

At this point, the tech stocks have once again gotten way ahead of the broader unweighted index, suggesting tougher economic conditions for many stocks.

No, I’m not yet warning of another plunge, but I am concerned about the fragility of the underlying economy.

With unemployment appearing to reverse improvements with this week’s initial jobless claims data, a slip in the Bloomberg Consumer Comfort Index and a hold up in Congress for continuing fiscal relief, the economy has issues to overcome.

Bonds, A Better Bet

Bonds in the US remain a better bet in terms of safety, growth and income. The overall aggregate bond market comprised of all bonds in the US has returned nearly 7% year to date. This is way better than even the tech-heavy S&P 500.

And for municipals, the market is up nearly 3.8% year to date. This also compares well against the weighted S&P.

But US corporate bonds rule with a year to date return of 7.1%, trouncing the broad and municipal bond index returns as well as the stock market, weighted or unweighted.

US Aggregate (White), US Corporate (Orange) & US Municipal (Gold) Indexes Total Returns—Source: Bloomberg Finance, L.P. & Barclays

The Federal Reserve has a lot to do with the bond markets’ favored returns. The Fed will keep buying and owning bonds for years and years to follow, much like it did after the 2008 financial mess.

The Fed will also provide a backstop for cash and credit markets again for the foreseeable future. Inflation is nowhere to be seen. Labor supplies will keep costs low, and commodities and energy will not be a problem.

As a result, the core Personal Consumption Expenditure (PCE) at a current rate of 1% is nowhere near the mid-2% rate needed for the Fed to think about reversing its easy money policy. And with inflation so low, bonds remain bargains. Well, except for Treasuries.

Treasuries are yielding so little that even with the PCE so low, real yields (the nominal yield less inflation) for Treasury bonds going out to 20 years are negative and barely positive going out to 30 years.

US Treasury Yield Curve—Source: Bloomberg Finance, L.P.

This makes higher-yielding corporate and municipal bond investments all the more desirable, and it’s why I continue to recommend a collection of funds and ETFs focused on corporate bonds and municipal bonds throughout all of the Profitable Investing model portfolios.

Corporates can be easily accessed with the Vanguard Intermediate-Term Corporate Bond ETF (VCIT), while municipals can be accessed with the SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI).

Less risk from inflation, less risk from politics and Federal Reserve support means bonds are a safer source of growth and income versus the general stock market.

All My Best,

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