Bonds Yields Offer An Alternative To Stocks

Let's go back in time to a time when dinosaurs ruled. That was the beginning of 2007 when everyone had Blackberrys and the first iPhone had not yet gone on sale, much less altered the technological landscape. The last time U.S. Treasury bills yielded 5% interest was this distant age.

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The five percent rate is a rate that is risk-free, and it is a far higher rate than what anyone under the age of 40 may be used to. There was a period following the 2008-09 financial crisis during which T-bill yields hovered around zero percent most of the time, apart from a brief move into the 2% range by 2018. With the outbreak of the Covid-19 pandemic in 2020, their fortunes plunged again. As the Federal Reserve sharply increased its short-term interest-rate target to 4.50%-4.75% at the beginning of last year, interest rates began to rise sharply, and they began to climb last year as well. For the first time since April 2007, T-bills due in six months topped the 5% mark this past week with two more quarter-point hikes likely in March and May.

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Increasing short-term money-market yields has far-reaching implications beyond allowing savers to earn a decent return.

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This past week, Peter Oppenheimer, chief global equity strategist at Goldman Sachs Asset Management, observed that a 5% yield with zero volatility risk is very high. This is especially true considering the S&P 500 trades at a price/earnings multiple of 18.5 times - far above its 20-year average of 15 - which is one of the highest multiples in history. TINA (There Is No Alternative to Equities) has been replaced by TATA (Treasuries Are the Alternative) by Douglas Kass, head of Seabreeze Partners Management. Peter Boockvar, chief investment officer at Bleakley Advisory Group, says T-bills are providing roughly three times the S&P 500 dividend yield of 1.65%.

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Kotok says he has a very high cash position in his clients' portfolios of exchange-traded equity funds due to the yield gap. Lotfi Karoui, Goldman Sachs Asset Management's chief credit strategist, said on the unit's webinar that investment-grade corporate bonds now offer the smallest additional yield margin ever.

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In contrast, the iShares iBoxx $ Investment Grade Corporate BondLQD +0.10% exchange-traded fund (ticker: LQD) had a 30-day SEC yield of 5.02%, according to sponsor BlackRock, which is characterized by greater credit and interest-rate risks.

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Considering these developments, James Kochan, an adjunct faculty member at the University of Wisconsin-Milwaukee business school and a former fixed-income strategist at Merrill Lynch and Wells Fargo, recommends investors focus on Treasury bonds with a one-to-two-year maturity and Treasury inflation-protected bonds with a one-to-five-year maturity. Despite substantial increases in the consumer price index, the latter should continue to benefit, he writes. Large, low-cost funds in the sector include the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) and the iShares 0-5 Year TIPS BondSTIP 0.00% ETF (STIP).

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On the risk scale, Kochan favors shorter-term high-yield funds, since defaults should be limited by the economy "doing well enough." The SPDR Bloomberg Short Term High Yield BondSJNK –0.00% (SJNK) and the iShares 0-5 Year High Yield Corporate BondSHYG +0.02% (SHYG) are two short versions of the major high-yield bond ETFs. GSAM's Karoui, however, would avoid leveraged lending in this sector. In addition to boosting returns, floating rates add to borrowers' burdens at a time when their revenue is being squeezed - a recipe for disaster.

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Municipal bonds, one of Trade Algo's income picks for 2023, have rallied strongly since the turn of the year. That's good news. They have risen in price, which reduces their yields for those who buy now. Kochan avoids munis due to their low yields, which are just 65% higher than comparable Treasuries. According to him, a 75% ratio represents fair value.

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Cumberland Advisors' director of fixed income John Mousseau says longer-term munis still offer attractive yields, with mid-investment-grade credits yielding 4.50%. Those yields would be well above the federally taxable 3.90% yield on a 30-year Treasury for an investor in the 35% bracket. Further Fed rate hikes will result in a negatively sloped yield curve (short maturities above longer ones), which will ultimately hit stocks and spark a bond market rally.

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According to Charles Lieberman, chief investment officer at Advisors Capital Management, rates are likely to rise in the near future. In addition, he favors real estate investment trusts with healthcare exposure for his clients. Among Lieberman's picks are Medical Properties Trust (MPW), Omega Healthcare Investors (OHI), Sabra Health Care (SBRA), and LTC Properties (LTC). There is a range of yields between 6% and 9% for these investments.

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Treasury bills yielding upwards of 5% and exempt from state and local income taxes are still tough to beat near term. Even though they offer all the excitement of a flip phone.