Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
I decided to create my own acronym, MEMS. Why not? This melodrama, embellishment, madness and sensationalism of reporting economic news and market forecasting invents my “MEMS” acronym. Of course, this is pure ridiculousness but humor me for a spell. It seems like nearly every news media outlet’s primary goal is to increase viewership. Apparently, this is done better by reporting the “extreme” story, the exception to the rule or undocumented, non-vetted, impossible to substantiate claims or forecasts. The output appears to send waves of fear and/or uncertainty to onlookers sometimes even changing investor behavior.
We’ve been living in an economy of low inflation where deflation has been a bigger concern than inflation for years. Now, we are experiencing some inflation and headlines would suggest that Armageddon is upon us. The Fed is forecasting inflation to be 2.3% and 2.2% and economists are forecasting 2.6% and 2.1% for the next two years. No hyper-inflation and pretty much in line with where the Fed has been attempting to get inflation for years. Investors have seen their wages, house prices, stocks and bonds all outpace inflation for decades, creating higher standards of living and growing net worths. A correction or bump in wages for lower income earners (essential for these households) which can snowball to higher prices in some sectors may be long overdue. This hardly qualifies as a disaster or rationale to change long term investment strategy. Even with the recent inflated prints, inflation has averaged 1.9% over the last two years.
Interest rates have been in a general decline for four decades. No one seemed to care because as interest rates declined, prices moved up. Therefore, while holding an individual bond, the paper profit increased. The reality is that bonds continued to perform exactly the same regardless of price movements. The price increase did not change the cash flow or income being produced, just the psychological feel good that the statement price was higher than the purchase price. Fund managers who sold some of these profits to boost return then had to reinvest those funds at a lower yield. If interest rates begin to rise, this will allow investors to increase their yields despite some red marks (losses) that will appear on statements. The higher income and cash flows will be locked in just the same as when rates were falling.
We sometimes lose sight of the importance of fixed income as a protection of our wealth. Fixed income may not make you wealthy, but it will help prevent you from losing your wealth. I have seen articles suggesting that since bond yields are so low, you should replace your fixed income allocation with dividend paying stocks, closed end funds or high yield bond funds. There is nothing wrong with these options for growth allocation; however, the market risks, liquidity risks, pricing risks, and leveraging risks are counterintuitive characteristics for the portion of your portfolio dedicated to protecting your wealth.
These are just a couple of the more recent MEMS. Don’t get sucked in. I’m suggesting we keep rationale, understand the purpose behind asset class selection and strategize for the long term, not based on MEMS.
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.