With the U.S. government having recently auctioned off Treasury bills at 0%, the Fed is sending a clear message to the average investor: If you want more, take your money elsewhere. Advisors should consider these developments when evaluating fixed-income opportunities for clients during the financial crisis:
Long-term bonds: The average investment-grade-quality long-term bond has increased several percentage points since Treasury rates were lowered. Shorter-term bonds have not moved as much because of their shorter maturities, which offer little incentive to institutional investors who are looking for sustainable long-term yields. As the quality long-term bond market gets saturated and yields drop, investors holding cash will look elsewhere in order to feed their desire for an attractive/acceptable interest rate yield. It is important to keep in mind that all bonds contain elements of interest-rate, credit, and market risk, if sold or redeemed prior to maturity and that market fluctuation affects the availability of bonds as prices are inversely related to interest rates.
Preferred stocks: Preferred stocks have suffered from a massive sell-off in the market as investors moved to cash. Hedge funds have liquidated significant positions in preferreds after being forced to raise cash when their investors have sought redemptions. As a result of the sell off, many REIT, utility and financial preferred stocks have dropped in price and now have been priced to potentially pay attractive dividend yields.
Dividend income: Some companies have maintained a dividend paying policy and have continued with relatively strong fundamentals. In fact, many common stocks offer attractive dividend yields and the potential for price appreciation. Many investors now are seeking income and potential capital gains, so dividend income stocks may participate earlier in a stock market rebound. Of course dividends alone are not enough to substantiate any equity investment. Overall fundamentals, such as a company's earnings, future sales potential, market share and other key factors need to be considered.
High-yield bonds: Yields are at historic spreads over a U.S. Treasury, making some junk bonds an attractive opportunity because they may offer a good income stream and possible appreciation in the underlying bond. It is important to consider that high-yield bonds carry additional risk-up to and including default due to lower credit quality. It should also be taken into consideration that U.S. Treasuries are guaranteed by the U.S. Government as to the timely payment of principal and interest while other bonds are not.
Municipal bonds: The municipal bond market has experienced the proverbial, "throw the baby out with the bath water" syndrome this year. Again, due to massive sell-offs from investors as they ran to cash, the municipal bond market has experienced a rather harsh reduction in pricing. Many of the quality municipal bonds have been priced to less than 70 cents on the dollar. This simply means that the market has already priced in an approximate 30% default rate for this category. To clarify, default simply means that the municipality is unable to repay their debt. A price drop is not always a negative. As long as the income stream remains, all purchases at the lower price can mean a higher dividend yield. The bonus card for municipals is that the interest is free from federal tax and possibly state tax. Some municipal income can be subject to the federal alternative minimum tax. The state tax exclusion is dependent upon what bonds you own.
I hope this commentary provides some understanding of current market conditions and assists with the ability to see through much of the negative press as we continue to seek investments options that take advantage of the current market.
Darryl S. Dyche, CFP, ChFC, AEP. is a financial advisor practicing at 335 North Jeff Davis Drive in Fayetteville, Ga. He offers financial planning as an investment advisor representative of Commonwealth Financial Network-a member firm of FINRA/SIPC, and a registered investment advisor. He can be reached at (770) 461-8191 or at firstname.lastname@example.org.