Market Pulse: Complacency in the bond market
August 6, 2014
Last week's announcement that the economy grew 4 percent in the second quarter jolted the bond market. Rates rose and prices fell.
That was a warning shot. Income investors had been very comfortable with their holdings. Complacency may prove costly.
In the spring of 2013 Ben Bernanke said the Fed's bund buying would someday end. The resulting "taper tantrum" sent bond prices lower. That, in hindsight, was a fantastic buying opportunity.
Many fixed-income instruments recovered the lost ground and then some. We can see that by looking at some of those I've highlighted in past articles.
In our October 17, 2013 article, "Sluggish Economy Benefits Income Investors," we featured three preferred stocks: RenaissanceRe Preferred 'E', PartnerRe Preferred 'D', and Annaly Capital Management Preferred 'D'.
All sat at or near their highs last week, with RenaissanceRe leaping 20 percent since that article. RenaissanceRe now yields less than 6 percent. Upside potential is now limited and the preferreds would move lower when interest rates rise.
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Utilities have been the darlings of Wall Street. Rising eight percent year-to-date, it's one of the best performing sectors. The yield on many utility stocks has fallen below 3 percent.
The yield on the Utilities SPDR (XLU) is 3.6 percent. I've lightened up on utilities in client portfolios. Once again, there isn't much upside.
What fixed-income is attractive? My largest holding is HSBC Adjustable Rate Series D Preferred. This investment-grade security is tied to the Treasury market, which is far more attractive than other adjustable securities that are tied to Libor.
It currently pays 4.3 percent and its dividend will increase when long-term Treasury rates rise about 1.5 percent from here. For more yield I like Saul Centers Preferred 'C,' which yields 6.8 percent. Also, Atlas Pipeline Partners Preferred E, which yields 8 percent.
Bottom line: It is inevitable that short-term interest rates will rise (they have been virtually zero for five years) and longer-term bond yields will climb as the economy expands. That will be both good and bad.
Cash-heavy investors, many of them retirees, who have patiently waited for better yields will finally have the opportunity to generate more income. Good for them.
Those investors who increasingly reached for high yields in riskier assets won't be cheering.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.