Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
Last week I discussed how there were no “freebies” in fixed income. Generally speaking, if there is a higher yielding bond than say a relatively riskless Treasury, than there is likely more risk associated with it. Risk is not bad. Think of it as a measuring stick to help define your own tolerances as an investor. By understanding one’s own risk tolerance level, it allows you to maximize your portfolio return.
Many investors understand the downside of risk. Investing in a company that is on the verge of bankruptcy may net us a very high income (yield), but many of us are unwilling to take the risk that it defaults. We not only fear the discontinued interest payments, but the loss of some or all of our initial investment too.
The other side of risk also may prevent optimizing our portfolio return. Many investment alternatives exist but if we only choose the safest of credits, we cheat ourselves of the income-earning potential of our hard-earned money. So where are you positioned for risk and are you maximizing your portfolio returns?
COVID-19 has changed the way we behave, work, play, take precautions, socialize, travel and perhaps even invest. Our nation has virtually shut down for 3+ months. Airlines, hotels, car rentals and all sorts of buying behaviors have been disrupted if not even halted. Naturally, this incites changes in perspective and differences of opinion. It is these disparities that foster angst for some investors while releasing possibilities for other investors.
We can expect that many corporations and municipalities will experience weaker financial and debt metrics caused by the economic disruption of COVID-19. That is about where the agreement ends. There are many investors that see permanent disruptions, closings and perhaps an altogether different way that business will be carried on going forward. Businesses may no longer rent or own large complexes as employees can accomplish their work tasks just as easily from home. Employees will no longer take to the skies and rent hotel rooms given that they can conduct business via teleconferencing. Mass transit rails and tunnels will turn to ghost towns as no one will chance infection by commuting in masses. Sports teams will perform in empty stadiums and movie theaters will turn into parking lots.
Or not. A vaccine could end the threat. Masks could be tossed and all these distractions simply vanish. Hotel occupancies climb while travelers refill airplanes and mass transit vehicles. Professional stadium vendors resume selling $10 beers and $5 hotdogs while Hollywood actors once again perform.
So who is right? A plausible case can be made for many extreme or even mildly different future forecasts. But, as the future has not been played out yet, there is no one that can speak with 100% certainty. So the differences of opinion and outlooks create our markets. Every time one investor is buying ABC stock or bond with the expectation of being paid a defined interest or anticipation of an appreciated price, the seller is likely viewing the future of ABC more pessimistically.
I’m not trying to change anyone’s mind or beliefs. I am certainly not suggesting you change your risk profile. Quite the opposite. I’m suggesting you listen to your own risk profile. If the world is going to change in your viewpoint, then take all the necessary precautions and eliminate unwanted risks in your portfolio. If you believe the pandemic is temporary, there are market dislocations to consider.
If you believe Yankee Stadium or Wrigley Field will once again host millions of fans, perhaps weakened associated bond prices are actually an opportunity for widened spreads and higher income. If you think employees will return to routine commutes, perhaps distressed mass transit bonds are actually an opportunity. If you believe business and pleasure air travel will resume, perhaps crazy wide airline spreads present welcomed income.
Define who you are as an investor and position and optimize your portfolio based on that. Do not take uncharacteristic risks but don’t leave earning potential on the table.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Stocks are appropriate for investors who have a more aggressive investment objective, since they fluctuate in value and involve risks including the possible loss of capital. Dividends will fluctuate and are not guaranteed. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
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