Read the weekly bond market commentary from Doug Drabik.
September 17, 2018
The talk of the financial markets continues to be a potential inverted yield curve. An inverted yield curve occurs when short term rates are higher than longer term rates. The challenge today often becomes bringing some sense of reality to the fear pounding message driven by media headlines. Here are some key highlights worthy of review for fixed income investors:
- Bonds are not stocks and neither should be treated as a substitute for the other. Many investors buy bonds primarily to protect their wealth and secondarily to provide income and steady cash flow. Stocks are typically purchased to provide growth. Both asset classes characteristically excel in their specific goals and often can fall short when reaching beyond their purposes.
- The significance of the previous bullet point is that stocks thrive on total return. Growth is driven perhaps partially by dividend income and largely on appreciation. Bonds accomplish their goal by being fixed. When held to maturity and barring default, the income and cash flow is fixed throughout the life of the bond. In addition, a bond’s face value is returned on a specific date. Income and return of face value occur regardless of price fluctuations that occur during the holding period. In other words, total return is not a driving force for held to maturity bonds.
- As highlighted in last week’s commentary, whether the curve inverts or it does not invert, there will be no change to income or a maturity date for a bond held to maturity in the portfolio.
- When holding bonds to maturity, resist the agony of watching price fluctuations. They won’t matter or change the bond’s performance.
- Many headwinds continue to exist for higher interest rates. Out-guessing rates, the yield curve and future events has proven difficult for the greatest financial minds. A simple proven strategy ladders maturities. Laddered strategies mitigate interest rate risk, can improve yields and provide a very structured return of principal to reinvest on an ongoing basis.
- A short duration bond should not necessarily dictate bond selection. Balancing heavily weighted growth assets such as stocks may best be achieved by maintaining moderate duration with fixed income holdings. The negative correlation between moderate duration bonds and other asset classes could provide a more ideal balance of income and principal protection.
- Over the last 30 years, upward sloping curves occur 92% of the time. Even if the curve does invert, it is likely to be short lived. Fixed income investing is a long term practice. Maintain investing discipline and resist reaching outside this discipline.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.