The worst income investments for 2022
This week Barron presented the tenth installment in Andrew Bary’s ever-popular list of the best income investments for the coming year. So in counterpoint, here is my take on the worst income investments for 2022. Hint: They’re all longer term bond funds.
The test I use stems from the wisdom handed down to me decades ago by the legendary Dan Fuss, vice president of Loomis Sayles, whose career in fixed income management dates back to the 1960s. “I like the bonds that rise”, I remember very well saying to him when we first met. And by that, he meant their prices, which move in the opposite direction of their returns.
But it looks like yields are more likely to rise in 2022, a trend that appears to have started on the very first trading session of the New Year. Of course, not much can be gained from one-day trips. But Monday’s sharp jump of around 13 basis points in long-term Treasuries, the biggest one-day move since November 9, 2020. That day,
(ticker: PFE) and
(BNTX) released the first results of a study that found their vaccine to be 90% effective in preventing Covid-19 infections, prompting optimism that the pandemic may end. (One basis point is 1/100 of a percentage point.)
This spike in yield has translated into sharp price declines for major exchange-traded bond funds, which is how retail and institutional investors frequently gain exposure to fixed income today.
The $ 19.2 billion
IShares 20+ Treasury Bond
The ETF (TLT) plunged 2.33% on Monday, which would equate to a drop of more than 800 points in the
Dow Jones Industrial Average.
More importantly, this price drop exceeded the fund’s 30-day SEC return by 1.74%, demonstrating the unfavorable risk-return trade-off of long-term bonds.
Even after Monday’s big yield save. JP Morgan treasury strategists estimated that the benchmark 10-year Treasury yield was still 30 basis points too low at 1.66%. This estimate was based on their model’s expectations for economic growth, inflation, and Federal Reserve policy rates. According to CME FedWatch, the federal funds futures market continues to expect three 25 basis point hikes by December from the current target range of 0% to 0.25%.
According to JP Morgan’s forecast, other large, popular bond ETFs would experience price losses well in excess of their yields, resulting in a negative total return. (The iShares ETFs listed here follow generic indices and are the largest examples. Comparable ETFs from other companies would have similar characteristics.)
For example, the $ 17.5 billion
7-10 Year iShares Treasury Bond
The ETF (IEF), which is half as volatile, based on portfolio duration, as the aforementioned 20+ year ETF, is expected to fall by 2.4% in terms of price, based on an assumed increase in yield of 30 basis points over the entire portfolio. This is nearly double the 30-day SEC return of 1.28% of the ETF. (Duration is a measure of the sensitivity of prices to changes in yield; the maturity of a bond is the primary determinant of its duration.)
The $ 91.5 billion iShares Core US Aggregate Bond ETF (AGG), which tracks the US taxable debt market, including mortgage-backed and corporate securities, would fare a little better. A 30 basis point increase in the portfolio yield would cause prices to fall by around 2%, more than the ETF’s 1.54% SEC yield, based on its duration.
The other bond sectors are valued at historically low yields compared to benchmark Treasury bills. This means that if they come close to their usual relative returns, their price drops could be even larger.
On the sole basis of an assumption of a 30 basis point increase in Treasury yields, the
IShares Corporate Bond iBoxx $ Investment Grade
The ETF (LQD) is expected to fall by around 2.9%, more than its SEC yield of 2.38%. Baa corporate yield spreads are close to previous cyclical lows, according to data from the St. Louis Fed. A widening of spreads would lead to deeper price declines and poorer total returns.
Municipal bonds could be relatively less exposed, but still not come out unscathed under JP Morgan’s scenario. Based on its duration, the iShares National Muni Bond (MUB) ETF is expected to fall around 1.7% from a 30 basis point increase in yields, almost double its SEC yield of 0, 88%. Historically, however, Muni yields have tended to rise somewhat less than their taxable bond counterparts.
But munis’ tax-free yields are currently relatively low compared to benchmark T-bills. According to the Citi Daily City Note, 10-year investment grade tax-exempt bonds only yield 63.8% as much as the corresponding T-bills, making their yields attractive only to those in the bracket. highest federal tax rate of 37%.
The investment record for bonds is now worse than during the big bearish bond market of the late 1970s and early 1980s. Unlike today, then bonds actually had high current interest coupons. , often in double digits, which helped offset declines in bond prices. In addition, the Fed is expected to end its massive purchases of mortgage-backed securities from the Treasury and agencies by March, removing a significant component from bond prices.
It is only if bond yields resume their decline from here that they look like a good deal. And of course, many leading professionals such as Scott Minerd of Guggenheim and David Rosenberg of Rosenberg Research believe that long Treasury yields will fall if the economy collapses again, as they expect.
But more days like Monday will mean losing bonds in 2022. I would stick with Andrew’s choices.
Write to Randall W. Forsyth at [email protected]