Market Overview
The long and short on bonds
Sometimes the best stock to pick is None of the Above. This seems to be one of those times.
As you read above, the stock market lost 9.2% last month. There were few winners. US News and World Report lists the top 10 performing stocks year-to-date. You’ve probably never heard of any of them. These are not the mega-caps that attract the most attention among retail investors. They’re niche players in biotech or energy-adjacent firms that are spiking because of supply disruptions throughout the world. Maybe one or two are keepers. We’ll see.
Exxon Mobil and ConocoPhillips are the only mega-caps that have materially appreciated in the past 12 months. But let’s not lose sight of how very cyclical the Energy sector is. If history is any guide, these gains will not be locked in.
So, if stocks are so volatile to the downside, where should you be investing?
Consider bonds.
Risk and reward
Fixed-income securities are really attractive now. Again, as we noted above, the benchmark 10-year Treasury ended September at 3.8040%. Yes, that’s higher than the 3.1330% yield at the end of August but, more importantly it’s much better than the 9.2% loss average investors took on their stock portfolios in September.
Let’s factor in one more thought, though. Stocks are inherently risky. Prices go up and down constantly and sometimes dramatically. That’s what being an owner is about – tolerating risk. The expectation is that, over time, that risk will provide greater reward than fixed-income securities in your portfolio. Companies can dilute their stock with new issuance or buy it back if it’s undervalued. They can offer stock dividends and they can cancel them. But they have to pay off their debt obligations first, so there’s really very little risk in the investment-grade bond market over the long term.
And when that “company” is the U.S. federal government, that’s the ultimate “Too Big To Fail” scenario. If Uncle Sam defaults, your portfolio might be the least of your worries. So, which would you rather have: A risky investment that plummeted 9.2% last month, or a risk-free investment that paid 3.8040% per year?
One bad month – or quarter – shouldn’t cloud your judgment. Investment is about looking to the future, not the past. Stocks could snap back any time. But the smart money seems to be telling us, “not anytime soon”.
Investors today ignore the bond market at their own financial risk.
The gap
We’ve written a lot in this space about the ramifications of an inverted yield curve, when short-term notes pay higher interest rates than long-term bonds. We’re in that situation now, but let’s not overstate the case. Economist Bill Connerly wrote an interesting piece in Forbes’s online edition about how imperfect a predictor the inverted yield curve really is.
The recessions “which began in 1953 and 1957 were not preceded by yield curve inversions. So, this concept is not perfect by any means,” according to Connerly, who further notes that, in 1966 and 1986, the yield curve inverted without a recession.
It’s important to remember why the yield curve is inverted: expected inflation. Most of us believe that higher-than-accustomed price increases will be with us for the next year or so, but the future beyond that is murky. Considering the Federal Reserve’s muscular approach to taming inflation – even if it means sparking a recession – it’s doubtful that this instability will continue over the long term.
Short-term pain, long-term planning
So how should you play this?
First, you probably shouldn’t go all-in on bonds. It’s a tough position to be in if you have to live off a cash flow that is dependent on the vagaries of Fed policy. That said, buying short-term bonds is an opportunity – now – to make some extra pin money. But long term, you’ll want to match the duration of your bonds with your own time horizon.
This is complicated stuff, and it just gets more complicated. In addition to corporate and government bonds, there are also tax-advantaged municipal bonds to consider. You’d be well advised to talk with a trusted financial professional before moving into this space.
