A funny thing happened last week when news broke that inflation had hit a four-decade high. A few strategists have started looking at bonds a little more positively, or at least a little less negatively.
In March, consumer prices were 8.5% above their level a year earlier, while producer prices were up 11.2%. As bad as these numbers are, they essentially confirm what we already knew and suggest that the pace of price increases may be nearing a peak.
But as major stock averages were down for the second week in a row (and the third for Dow industrials), the price decline in the bond market slowed. The yield on the benchmark 10-year Treasury note (which moves inversely to its price) rose 0.095 percentage points to 2.808%, taking the two-week rise to 0.434 points and the rise since the start of the month. the year to 1.312. points.
The sharp rise in bond yields has changed the calculus between equities and fixed income.
Last week, Truist Advisory Services lowered its recommended equity exposure to neutral, its lowest level since 2010, due to the decline in the equity risk premium (the extra return of stocks relative to bonds). The move reflects lower global economic growth, more rigid inflation trends and lingering geopolitical risks, as well as a tightening of Federal Reserve policy, which could mean growth could suffer if inflation is not under control, according to a research note.
While such tactical shifts are important for institutional portfolios looking to mitigate near-term risk, absolute government bond yields remain relatively unattractive, even as the real yield on hedged 10-year Treasury securities remains relatively unattractive. inflation approached zero after being below minus 1% early March.
Long-dated, investment-grade municipal bonds are much more attractive, with tax-free yields hitting 4%, the highest since late 2016, according to John R. Mousseau, CEO and head of fixed income at Cumberland Advisors.
The muni market is going through one of its typical feast-and-now-famine episodes, he wrote in a client note. Tax-exempt bond funds saw outflows of $4.8 billion in the week ended April 6, the most since the financial market meltdown in March 2020, according to data from the Investment Company Institute. reported by the bond buyer. Muni fund managers are selling what they can to meet redemptions, overwhelming Wall Street dealers with supply, he adds.
The result is a buyer’s market, with those 4% tax-free returns equaling 6.35% on a taxable security, he writes. Indeed, 20-year-old double-A munis earn about the same as their fully taxable corporate counterparts in the low 4% range.
What Cumberland is trying to buy are bonds issued last year at 2% to 3%, which have suffered a “breathtaking drop in price,” Mousseau adds in an email.
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Bonds initially offered around par can now sell for around 70 to 75 cents on the dollar with a yield to maturity of 4.15% to 4.25% for 30-year paper. This fall in prices is not linked to credit problems, but simply to higher yields, he points out. Of course, there are tax complications with discount munis, but they still yield 0.15% to 0.20% more than new bonds at par, even after taxes.
If you’re looking to add bond ballast to a balanced taxable portfolio, munis might be your best bet.
Write to Randall W. Forsyth at [email protected]