Over the past 60 days, the consumer price index rose above 9% before stabilizing a bit, the Federal Reserve raised short-term interest rates by three-quarters of a percentage point with promises of new increases, apartment rents continued to soar to double digit rates, and much more. You could feel the fixed income markets exploding in a bonfire for the ages.
Bad. Since June, we have instead benefited from a noticeable bond rebound. It makes sense and could continue.
With economic growth slowing (or remaining negative) and falling oil and other commodity prices rippling through the economy, there is no reason for medium and long-term interest rates to are high. Fed statements and rate hikes are aimed at dampening inflation. This rally tells us that the markets expect consistently lower inflation to arrive sooner rather than later.
Thus, the yield on a 10-year Treasury note plunged from 3.5% on June 14 to 2.6% in early August. This increased the net asset value of a typical treasury fund by more than 4%. (Yields and prices move in opposite directions.) Other bond averages, such as high-yield (junk) corporate bonds and taxable municipalities, gained (or regained) even more. How can that be, with all the worry about stagflation – amplified by the strident politics of this election year? And how should we manage our yield-seeking dollars?
First, don’t put them all in the bank. Banks don’t follow Fed rates up the scale. And bonds are secure as long as you are paid on time and in full. There are no worrying credit problems, bank failures, massive foreclosures or other echoes of the financial crisis. Second, although the core values of bonds and bond funds fell early in the year, this allowed vigilant bond fund portfolio managers to accumulate higher-coupon assets and increase their cash distributions. . This is visible across all categories, maturities and credit ratings.
Take the Vanguard GNMA Investor Fund (VFIIX). In January, he distributed $0.00824. Annualizing this and dividing by the (then) NAV of $10.54 yields a return of approximately 0.94%. In August, the same fund distributed $0.02103, more than double, on an NAV of $9.89 (compared to a low of $9.36 on June 14). The current yield is 2.5% and the total yield is 4.6% from June 14 through August 5. As mortgage rates gradually decline, this should further increase NAV as fixed rate mortgage pools become more valuable until and unless loan rates drop enough to trigger a new massive refinancing. It will be a while.
Turn to Dodge & Cox Income (DODIX), a solid core fund that holds high-quality mixed bonds. It pays quarterly, and in December 2021, it issued $0.057 per share on an NAV of $14.05, a yield of 1.6%. After falling to $12.44, the fund rallied to $12.90 and pays $0.077, for a return of 2.4%.
Moving on to high yield bonds, look at the Fidelity Capital & Income Fund (FAGIX). After losing 15% earlier this year, the fund halved that loss within weeks while steadily increasing its monthly distribution; based on the latest installment, its yield is up to 4.3% after starting the year just above 3%.
These are three funds that I know many of you hold that have served investors wonderfully for a long time. I could cite hundreds of others. Abandoning proven investments during a mild economic downturn and a few weak quarters is short-sighted.