When compared to just one month ago, global bond prices have risen across the spectrum, with the benchmark 10-year yields falling in tandem after peaking in October.
Source: www.bloomberg.com
The dash from cash into fixed income in all its forms has been evident. Everything from government sovereigns, government agencies, investment grade corporate, non-investment grade corporate, municipals, preferreds and CDs have been met with a huge appetite from both institutional and retail investors. The rally in the U.S. 10-year Treasury triggered by the tame Consumer Price Index (CPI) and Producer Price Index (PPI) readings caught much of the investing world flat-footed, still entrenched in the Fed’s ‘higher-for-longer’ narrative, with some added emphasis that another rate hike might be necessary to finish the job.
Instead, the market decided that not only was the Fed done, but that two or three quarter-point rate cuts for 2024 was the more likely scenario to play out. By historical measures, the adjustment in yields was radically sudden, almost an overnight reset of expectations brought about by the change in narrative, but also the forward growth predictions that point to a marked slowdown in GDP for the current quarter. The latest Atlanta FedGDP Now shows the economy growing at a 2.1% rate for Q4 — not too hot and not too cold — just what the bond market is loving.
This number will likely get a bump following a record Black Friday-generated $9.8 billion in U.S. online sales, according to Adobe Analytics, up 7.5% from a year ago. Lower gas prices and food prices heading into Thanksgiving are boosting consumer sentiment amid strong wage gains, and a strong labor market offset record consumer debt levels.
Under the assumption that the directive of the Fed to hit its 2% target for inflation is achieved so as to curb the soaring cost of interest on the federal debt, it stands to reason that while they will likely not raise rates further, they will want to see how healthy the consumer performs in early 2024 or whether there is a hangover effect from this year’s holiday shopping spree. So far, the U.S. consumer has surprised to the upside.
Against this wait-and-see backdrop by the Fed, it’s my view that the base case for the United States averting a recession is more credible now that just a month ago. In this environment, for investors that are willing to absorb more risk, non-investment grade bonds in the form of leveraged closed-end funds offer yields that can take some of the sting out of real household inflation without having to deal with single-bond investing.
To be sure, having a guaranteed 5% return on short-term Treasuries, agencies, investment grade corporate debt and money markets has been all well and good, but it doesn’t beat the cost of inflation and taxes in the real world. It’s been a great place to hide but hardly to place to get ahead of the rising cost of living. Now, with wind to the back of the bond market, it might make sense to add some high-yield risk with the economy looking more stable going forward.
Bear in mind that most closed-end, high-yield bond funds employ an average of 20-35% leverage to generate 10%+ yields in diversified portfolios with average maturities under seven years. A good place to shop for closed-end funds is at www.cefconnect.com, where investors can apply filters to screen for what fits best.
An example of what’s out there in this space is:
BlackRock Corporate High Yield Fund (HYT); Assets $1.9 billion — 10.8% Yield that pays out monthly and trading at a -6.5% discount to Net Asset Value (NAV). The fund has 1,181 holdings that makes for a widely diversified portfolio in the types of bonds that most retail investors would find very difficult to purchase through their brokerage accounts. Institutional investors gobble up the best high-yield issues as they become available, with many bonds trading in lots of only $100,000 or more. HYT is a holding within the Cash Machine model portfolio. To learn more about investing in Cash Machine, click here.
Again, this category came under fire when the Fed began raising rates and the cost of leverage soared, but there are positive changes under way, and by conducting some active research, the corporate high-yield space can deliver double-digit-percentage yields and potential for capital gains if the economy maintains steady growth, inflation continues to trend lower and the Fed ultimately begins to lower rates. When these factors come into line collectively, the total returns for high-yield debt can be downright impressive.
