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For so long fixed-income investors have felt financially pressured to invest in real estate investment trusts (REITs), dividend-paying stocks and high yielding securities they never thought would fit their risk profiles. So why’d they do it? Because back then bond yields were so limbo-low.
Fast forward to a more hawkish Federal Reserve. They promised two additional hikes this year and also slapped a Slim Fast diet on their balance sheet. If this actually comes to pass, rates just may move higher.
Some could perceive this as bad news. But it is not. Finally…finally the bond market sports some great yields with minimal risk.
Let’s assess where the value lies. With the yield curve so flat, a super safe parking spot is July 2019 Treasury Bills yielding 2.4%, and with no state tax consequences. It’s not worth considering 10-year Treasurys yielding a mere 50 basis points (1/2 of 1%) more for nine additional years to maturity.
How about corporate bonds? Glad I asked. Leidos, the scientific, engineering and technical services company has BBB- (S&P) bonds, 4.45% due December 1, 2020 yielding 3.77% to maturity.
Or consider Air Lease, the large aircraft leasing company with BBB rated bonds; 2.125% maturing January 15, 2020 yielding 3.37% to maturity. Before all these rate hikes you would have to struggle to feed that 3%-plus yield craving. Now—it’s pretty easy.
If 3% is not enough, Andeavor Logistics, which owns and operates natural gas pipelines, a network of crude oil, truck terminals and storage facilities, is an idea. In 2017 Andeavor changed its name from Tesoro Logistics—a name that may sound more familiar. This 4% (BBB rated) bond has a 3.50% coupon and matures December 1, 2022. Its yield of 4% doesn’t hold a candle to its 9.40% share distribution but man-oh-man what a difference in price volatility. Year-to-date shares have been as low as $41.40 and as high as $54.75 over a 24% price fluctuation.
The bonds, on the other hand, year-to-date have been as high as $100.40 and as low as $97.57. They are currently at $98.126. That’s less than a 3% move. So let’s say the Fed does raise rates twice more this year. If you buy the bonds at a discount at $98.126, then, yes, they will go down in value due to rate hikes but not much because they are so short term. If you hold until maturity you’ll get not only the 3.50% coupon, you will also receive a tiny increment between $1,000 face value and the discount $981.26 purchase price. It’s not a score by any means. But it does safely feed the yield beast within.
At this point in the interest rate cycle no one really knows what a ‘return to normalcy” means. It’s a nice Fed phrase. But still, with such a huge balance sheet and $15 trillion in Treasury debt outstanding—due and payable to others—what is normal anymore?
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