Dear clients and friends,
The yield curve for corporate bonds has become almost completely flat. What this means is that a 5 year bond is yielding (paying) almost exactly what a 1 year bond is yielding. Normally, you would earn more interest for longer bonds than for shorter ones. Right now, this is not the case, at least on the bonds that we are using. This has happened because the longer bonds have gone up in price, driving the yield lower which is of course a good thing.
We will be selling these longer bonds and moving to shorter bonds. Ideally the yield curve will regain its normal shape or interest rates will go up, at which point we will buy those longer bonds back at a lower price and a higher yield. Since they are currently all earning the same amount, we won’t be giving up potential interest while we wait for this to happen. If interest rates fall farther, then we could miss out on some potential interest, but in our opinion that risk is low.
In the high yield portion of our portfolios, we will be likewise shortening our bond ladders both for this reason, as well as because of potential price risk if recession fears increase.
Overall this is NOT a big move, but we believe it will be a bit safer, as well as hopefully earn a bit more on the fixed income portion of our portfolio once this weird pricing corrects.
As always, please don’t hesitate to contact us with any specific questions or concerns you may have.
Dear clients and friends,
The stock market was shaken by an indicator called a yield curve inversion. What this means is that 2 year government bonds were paying a higher interest rate than 10 year bonds. This is unusual and fundamentally shouldn’t be. The theory is that there is more demand for long term bonds because of perceived short term weakness in the economy. This makes the price of the long term bonds go up, and therefore the yield go down.
The reason the market is concerned by this is that there is a high correlation between this indicator and a coming recession. This indicator does not have a 100% track record, however, and the coming recession that it has predicted in the past has taken as long as 2 years or more to come to pass. Historically, after one of these signals, the market drops about 5% and on average rallies about 17% after that, before falling due to recession. To me, that reads as if this is a bullish indicator at least in the medium term.
Another point to take into consideration is that the Fed is playing a huge role in artificially controlling interest rates. This makes any indicator based on these rates suspect.
Our plan at the moment is to wait and see how the market reacts until there’s a larger overall move. There have been some big days, but the overall move from the peak isn’t that big in terms of percentage points. If the drop continues, we intend to purchase more stocks, and keep a close eye on profits to see if a recession actually is looming. On the bond side, our bonds have gone up in value, so we will start leaning more towards the short end of our bond ladder and when interest rates climb once again, we will once again go longer.
As always, please don’t hesitate to contact us with any specific concerns or questions.