The bond bull market is ending, but yield opportunities are on the rise, two Schwab managers told advisors at Schwab’s IMPACT conference in Philadelphia this week.
“How high will interest rates go and how will that look?” Matt Kuss, director of client portfolio strategies at Schwab Asset Management, asked the crowd of advisors during “The Great Interest Rate Reset: What’s Next?” session.
Most advisors in the crowd indicated that they believe the Federal Reserve may increase rates another quarter point, but that they expect the Fed to start cutting rates in mid-2024.
“I think there is no question that for longer-term investors, interest rates are really interesting now and in the future and more fully a competition to other risk assets. I do think there are opportunities there,” said John Majoros, co-head of taxable SMA strategies and senior portfolio manager at Schwab Asset Management.
Majoros’s firm, the Wasmer Schroeder Strategies, was acquired by Schwab three years ago and today manages 25 Wasmer Schroeder Strategies, including nine actively managed strategies, two positive impact and two ultrashort strategies and a series of 12 bond ladders. The minimum investment is $250,000 for each strategy.
“Given some of these elevated rate levels, do you see or anticipate investors making long-term asset allocations, because we haven’t seen these rates in a while. For us in the fixed-income space it is compelling,” Kuss said.
It is difficult to convince investors that they should make longer-term, fixed-income bond plays when they can get 5% for essentially zero duration, Majoros admitted.
But zero duration is zero duration and is unlikely to work for retirement and other long-term investment horizons because the economic underpinnings that support that short-term rate scenario appear to be changing, Majoros said.
“The curve is disinverted. You can tell the market believes we will get a slowdown. The thing I go back to with this environment is that the Fed is looking at history and the real challenge of getting this rate down to this magical 2% they’ve set. They can’t say OK we’re at 2.5% or 3%. I think people are still underestimating what the Fed will do,” he said.
If the U.S. does see an economic slowdown “we will see short-term rates come down. Will long-term rates come down? I believe they’ll stay higher,” Majoros argued.
For investors with a longer-term horizon, he said he sees “really big opportunities” in tax-exempt municipal bonds
“One reason is somewhat obvious, one not so obvious. In the tax-exempt market, rates are quite a bit higher. Tax-exempt municipals have cheapened quite a bit when compared to Treasurys over the last six months ago. Six months ago, municipals were pretty expensive anywhere on the curve, but now, they’re much cheaper.
“And I think if you like your bond investments to be safe to a certain extent, that municipal credit is in a really strong position. We’ve had a significant amount of money that has flowed from the federal government to keep municipalities strong,” he said.
Even if the economy slows, munis will hold up well because of the surplus of federal government funding, Majoros said.
“The other thing we like and happen to play a lot in is the taxable municipal market for our clients in accounts where they don’t pay taxes. Again fundamentally, this market is really strong,” he added.
While people think the taxable municipal market is small, it’s a $900 billion market, he said.
Taxable munis are "institutionally based and compared to corporates in a lot of ways, but they’re nothing like corporates. They’re clearly much safer. You don’t have to worry about the state of New York being taken over by California and getting all California’s debt. It’s obviously not what goes on,” Majoros said.
“What other areas of the market do you find interesting right now,” Kuss asked.
“I know a lot of people are fans of corporate credit. I tend to be in that camp. I think that from my perspective, large companies have gotten much better at balance-sheet management. They put a lot of money in at very low rates. So, I think there is a lot to like in the corporate bond market,” Majoros added.
“Overall, the public markets and corporate bond markets will probably see their credit ratings rise in coming years,” he added.
What should investors be wary of now, Kuss asked.
Majoros said he worries about stresses on the banking industry. “We saw a little bit of that in March and April of this year with the banks that were essentially taken over by FDIC.”
The other thing Majoros said he steers clear of right now is mortgage-backed securities. “I’m not a fan and one of the reasons we’ve had a very good year is that we’ve been very underweight in mortgage-backed securities,” he said.