Why bonds are shaping up to be the new alternative investment

As the recession outlook moves further down the road, advisors see the Fed keeping rates higher for longer, boosting the appeal of fixed income.

With the tech-led rally in the stock market pushing the S&P 500 Index up nearly 17% from the start of the year, it would be easy to overlook the opportunities in fixed income, but investors are finding a host of options for safe and decent yields.

While the yield curve remains inverted, with shorter-term bonds offering higher yields than their longer-term counterparts, it’s easy to find yields above 4% well down the curve, and with even money markets hovering around 5%, financial advisors will have portfolio allocation decisions to make.

“We don’t think the Fed will cut rates for some time, so right now bonds are the alternative to the traditional stock market,” said Max Wasserman, founder and senior portfolio manager at Miramar Capital.

“If you need long \-term returns above the rate of inflation, you have to put capital at risk,” Wasserman said. “But if the time horizon is short term, it looks very tempting to load up on short-term fixed income.”

Even though advisors and analysts find it easy to criticize the Fed’s monetary policy and flat-footed response to spiking inflation, there’s no denying that the current appeal of fixed income links directly to the Fed. And because it’s becoming difficult to imagine a near-term scenario in which the Fed will be cutting interest rates, advisors and analysts see an ample buffet of bond options.

“We see a lot of value having been restored to fixed income and we think it’s a good time to be dollar-cost-averaging back into bonds,” said Steve Hooker, managing director and senior portfolio manager at Newfleet Asset Management.

Like most folks, Hooker describes the economic data as “mixed,” muddied by record stimulus spending still coursing through an economy that is somehow defying the odds pointing toward a recession.

But those aggressive efforts by the Fed to try and head off inflation are finally starting to show up as a silver lining for fixed-income investors.

“Monetary policy acts on the economy with a lag and we’re starting to see the first signs of the policies put in place a while ago,” Hooker said. “It feels like we’re in the early days of seeing an impact. When you look at the economic data, it’s mixed, but mixed positive.”

The result, Hooker explained, is showing up in the form of investment-grade corporate bonds yielding 5.5% on average, at an average price of 90 cents on the dollar. “For long-term investors, we think that’s pretty attractiven” he said.

Ian Acosta, vice president at Taiko, is steering conservative investors toward the iShares Ultra Short-Term Bond ETF (ICSH) and VanEck IG Floating Rate ETF (FLTR).

“ICSH invests in investment-grade-rated corporations and boasts a duration of 0.45 years and a 5.1% 30-day SEC yield, and FLTR invests in investment-grade-rated bonds which have their interest payments float,” Acosta said. “With the rate increases implemented by the Fed, the 30-day SEC yield on FLTR has shot up to close to 6% on a portfolio of bonds issued by companies such as JP Morgan, Goldman Sachs, Verizon and others.”

Paul Schatz, president of Heritage Capital, is shrugging off the Fed’s June pause and expects interest rates to be bumped up another quarter point to half a point this year.

“I am literally laughing out loud at all those pundits who forecast one to three rate cuts in the second half,” Schatz said. “The Fed has been clear in their path. The markets and economy still have to reconcile the three quarter-percentage-point hikes from last year that are now filtering into the economy. I would expect weakening during the second half of the year but not recession.”

Such an outlook bodes well for fixed-income investors, which helps explain the direction of asset flows into bond ETFs.

According to Todd Rosenbluth, director of research at VettaFi, “fixed-income ETFs are punching above their weight in the U.S. and globally.”

“Despite representing 19% of U.S. industry assets, fixed-income ETFs gathered 49% of new money in the first six months of 2023,” Rosenbluth said. “That’s an impressive feat given the uncertainty in the economy and in the bond market.”