Here’s another knock against putting all of your retirement-income eggs in the bond market basket. This week is ushering in record low yields of less than 4% for high-yield corporate debt. While that yield is rich compared to the 10-year Treasury, using speculative junk bonds to provide the income investors expect from their fixed-income allocation can be risky when the good times end (see blue ovals below). For example, high-yield, as proxied by the Bloomberg Barclays US Corporate High Yield Index, lost 12.7% in total return in Q1 of 2020 as the pandemic hit. Today, yields are about 1.25% lower than where they started 2020.
At Horizon, we believe the Fed’s accommodative stance, coupled with the coming economic recovery, will keep high-yield valuations elevated. We own high-yield debt in our fixed-income portfolios, but we aren’t adding to that allocation at these yield levels. Rather, we currently prefer to express our positive stance on asset markets through a diversified set of alternative fixed-income instruments, including preferred equities, convertible bonds, bank loans and emerging market debt.
Elsewhere in the bond market, losses are already hitting longer-dated corporate debt. Bloomberg reports that corporate bonds with at least 10 years left to maturity have produced losses of around 3.2% so far in 2021, the worst start to any year since 2018. Corporate bonds are being hurt by the economic reflation trade and the duration risk that comes with holding long-term debt in a potentially inflationary environment.
And remember the Big Number report Horizon published on December 17 pointing out that investment grade corporate bonds now carry a negative yield when you factor in expected inflation? Since then, the inflation-adjusted negative yield has worsened to -33 basis points, as of February 11.
Inflation, however, is still a no show; at least that’s good news for bonds. The Consumer Price Index came in below economist expectations and core prices remain well below the Federal Reserve’s 2% target.
And Federal Reserve chairman Jay Powell’s speech indicated – once again – he’s years away from raising rates, which can keep a bid in bonds despite the potential risks posed by low yields, faster economic growth and inflation.
Shocking earnings season news keeps rolling in!
S&P 500 Q4 earnings and sales are now on pace to grow year-on-year, defying analysts’ forecast for a drop. The magnitude of the surprise is larger than the typical lowering-of-the-bar that goes on ahead of earnings season. Bloomberg Intelligence sees Q4 EPS growing 3.6% versus the analysts’ pre-season forecast for a drop of 8.8%. In our opinion, this will likely cause analysts to raise their 2021 earnings forecasts.
Such good earnings news is helping propel U.S. stocks to record highs, along with the prospect of trillions more in government stimulus and expanding vaccinations. The breadth of the advance has not been concentrated in large-cap tech stocks. The small companies are in fact the biggest gainers not only this week, but also off of last year’s lows. Horizon Investments recently added to its overweight on small-cap stocks versus large-caps given our optimistic outlook for the back half of 2021. Smaller companies are generally not a large allocation for many investors given the dominance of mega-cap companies in recent years. Horizon’s flexible, active approach allows us to take advantage of new trends as markets change.
Also making all-time highs are the S&P 500 equal weight index (another sign of a broad rally) , S&P 500 cumulative breadth and the MSCI Emerging Markets index.
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This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, contact Chief Investment Officer Scott Ladner at 704-919-3602 or firstname.lastname@example.org.
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