- Low rates have encouraged risk taking and growth has been supportive, leading credit to outperform rate-sensitive markets
- Growth is expected to slow and rates are expected to rise but remain low — creating challenges for investors
- Focusing on specific credit exposures and inflation-protected bonds may help investors reposition portfolios
Today’s complex environment has clients concerned with many variables that could alter the market’s trajectory: Policy normalization, tapering, low rates, fiscal spending impacts, inflationary pressures, expensive valuations, earnings growth stability, market gains concentrated around a few large stocks and the future path of an economy still dealing with the effects of the lingering COVID-19 pandemic. However, when grouped together, the through line of our client conversations centers on these two questions:
- How can I continue participating in a policy-supported rally marked by elevated valuations given concerns about the sustainability of future growth?
- Where can I source “real” levels of income within bond portfolios that can withstand rising rates?
In this second part of this two-part blog, I will address the second question related to bond portfolio positioning. Check out the first part on equities here.
The Key for Bonds: Get Real for Income
On the bond side of the portfolio, investors must navigate a potentially low return environment for core bonds, given the low starting point on yields and the potential upward bias in interest rates. Sidestepping bonds all together is problematic, however. Their potential diversification benefits could be important to risk mitigation if the rosy outlook above turns out to be more sanguine.
Yet, the issues on the return side are real. Currently, 88% of all investment-grade bonds trade below the market’s expectation for inflation over the next 10 years (10-year breakeven rates are 2.4%), leading to potentially a negative real income level for the largest part of the bond market.1 As shown below, there are very few exceptions in the bond market that can generate a real income level after accounting for inflation expectations.
1. Bloomberg Finance, L.P. as of September 8, 2021 based on the yields on holdings of the Bloomberg US Aggregate Bond Index less than US 10 Year Breakeven Rate
Bloomberg Barclays US Aggregate Bond Index
A broad-based flagship benchmark that measures the investment grade, US-dollar-denominated, fixed-rate taxable bond market.
The difference in yield between inflation-protected and nominal debt of the same maturity. If the breakeven rate is negative it suggests traders are betting the economy may face deflation in the near future.
CBOE VIX Index
The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.
Originally Posted on September 17, 2021 – Constructing Portfolios for the Fourth Quarter and Beyond: Bonds (Part 2)
The views expressed in this material are the views of the SPDR Research and Strategy team and are subject to change based on market and other conditions. It should not be considered a solicitation to buy or an offer to sell any security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. There is no representation or warranty as to the current accuracy of such information, nor liability for decisions based on such information. Past performance is no guarantee of future results.
This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.
Unless otherwise noted, all data and statistical information were obtained from Bloomberg LP and SSGA as of September 8, 2021. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.
The research and analysis included in this document have been produced by SSGA for its own investment management activities and are made available here incidentally. Information obtained from external sources is believed to be reliable and is as of the date of publication but is subject to change. This information must not be used in any jurisdiction where prohibited by law and must not be used in a way that would be contrary to local law or legislation. No investment advice, tax advice, or legal advice is provided herein.
Investing involves risk including the risk of loss of principal.
Prior to 02/26/2021, the SPDR Blackstone Senior Loan ETF was known as the SPDR Blackstone / GSO Senior Loan ETF.
Prior to 05/01/2021, the SPDR ICE Preferred Securities ETF was called SPDR Wells Fargo Preferred Stock ETF.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
SSGA Funds Management has retained Blackstone Liquid Credit Strategies LLC as the sub-advisor. State Street Global Advisors Funds Distributors, LLC is not affiliated with Blackstone Liquid Credit Strategies LLC.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from State Street Global Advisors and is being posted with permission from State Street Global Advisors. The views expressed in this material are solely those of the author and/or State Street Global Advisors and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.