Bond Investors Should Remain Focused on Short Term
With the Federal Reserve still in interest rate raising mode, bond investors should continue to avoid fixed-income investments with longer-term yields and keep their focus on the short term. That’s according to Collin Martin, director of fixed income for Charles Schwab’s Schwab Center for Financial Research, who said in an interview that the yields on longer-term bonds won’t rise at the same magnitudes seen in the first half of 2018.
“For now, I still think investors should focus on short-term fixed income. I don’t think the risk/reward makes much sense to extend the duration,” he said. According to Martin, a lot of the moves in the yield already occurred on the long end, and with the Federal Reserve raising interest rates as many as four times this year, the yields for longer-duration fixed income won’t rise as much. “For now, shorter-term investments are offering higher yields, but in case yields do rise, I’m telling clients to get closer to the point where it makes sense to start extending duration,” said the executive at The Charles Schwab Corporation, who expects the Fed to raise rates one or two more times this year.
In terms of where fixed-income investors should be setting their sights for now, Martin said he is currently neutral corporate bonds – both the investment-grade and high-yield variety. According to the bond strategist, for some time now, the corporate bond market has been booming, particularly in the investment-grade area. While Martin said that corporations can continue to service their debt for the time being, over the longer term, issues such as tariffs could result in bond investors requiring more of a risk premium, which could lead to higher spreads down the road.
“I don’t expect prices to suddenly crash. Prices remain supported because liquidity remains strong, cash balances are high and earnings are still doing really well,” said Martin. “We don’t think spreads are going to jump; we do think we’ll see more volatility.” Martin also urged investors not to be overweight high-yield bonds given that they have historically offered only “modestly positive excess returns over Treasuries over the next 12 months.”
The way the strategist sees it, risk to the corporate bond market is more of an issue for the second half 2019 and beyond rather than a worry for the current year. The approach of the late stage of the economic cycle and the Federal Reserve continuing to raise interest rates should start to eat into corporate margins next year, and the corporate bond market will likely see more significant risks from then on. There are also concerns that tariffs placed on goods coming from China and on imported aluminum and steel will start to hurt corporations and lower their profits.
Keep Bond Durations Limited
The Schwab strategist said that investors in taxable investment accounts should keep their bond investments in the average duration of two to five years to limit any interest rate risk. He also said that investors should be cognizant of the quality of the bonds they are investing in and seek out higher-quality fixed-income investments.
“Just because BBB is growing doesn’t mean all investors need to own BBB bonds,” he said. “Clients who are more conservative and don’t want to take on the risk should move up to higher-quality single-A or better” rated bonds. Typically, the riskier the bond, the higher the yield investors can receive. “The biggest point for investors is to look at what you own in your funds and ETFs and check the average duration and the average credit quality,” advised Martin