April 22, 2019: The Current State Of Fixed Income

Apr 23, 2019 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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Please note that we now list the next re-balance date on every portfolio page.

The Current State Of Fixed Income

We review the current state of fixed income. The following are key observations for the latest bond/fixed income markets

Yield curve is still inverted but improved

The first thing to look at in bond markets is the yield curve that started to invert late last year. Intuitively, interest rates (yields) for short term bonds should be lower than those of longer term bonds. For example, you would expect paying lower interests for your mortgage that are mature in 5 years than those that are mature in 10 or 30 years. If now, the interest rate for one year Treasury bill is lower than that of 5 years, two things could happen:

The one year rate comes down, signaling a further loose monetary policy to accommodate slower growth. 

Or the five year rate goes up. Usually this signals that economy (or inflation) should grow in this period. 

Currently, we are seeing that the yields on the much longer end (10 and 30 years) are now higher than those in the lower ends (1, 2, 3, 5 and 7 years). However, the rate of one year Treasury bill is still higher than those of 2, 3 and 5 years:

Regardless, the longer end rates are now adjusted: in fact, we can see from the above chart that rates of 2, 3, 5, 7, 10 and 30 years all rose from one month ago. 

Inverted yield curve (the lower belly) usually signals weakening economy or even recessions. At the moment, this is reflected in the last quarter’s earnings recession (lower earnings compared a year ago). However, it’s still not enough to predict a near term recession in this year. 

Long bonds are still doing better (for now)

As stated above, 10 year Treasury bond’s yield has risen recently (from late March):

But that’s not enough to move long bonds’ trend score lower than other shorter term bonds: 

Fixed Income Assets Trend

as of 04/18/2019

Description Symbol 1 Week 4 Weeks  13 Weeks 52 Weeks Trend Score
Emerging Mkt Bonds PCY 0.25% -0.07% 5.95% 5.73% 4.2%
Long Term Credit LQD -0.43% 0.94% 5.64% 6.76% 4.13%
High Yield JNK -0.08% 1.34% 5.78% 7.0% 4.04%
20+ Year Treasury TLT -0.53% 0.18% 3.4% 6.33% 3.84%
10-20Year Treasury TLH -0.6% 0.04% 2.87% 6.61% 3.44%
Intermediate Treasury IEF -0.42% -0.02% 2.56% 6.32% 3.05%
High Yield Muni VWAHX -0.18% 0.66% 2.89% 5.75% 2.94%
Long Term Muni VWLUX -0.09% 0.64% 2.62% 5.63% 2.93%
US Total Bond BND -0.2% 0.61% 2.73% 4.94% 2.67%
National Muni MUB 0.0% 0.51% 2.29% 5.08% 2.56%
MBS Bond MBB -0.21% 0.13% 2.27% 5.06% 2.52%
Inflation Protected TIP -0.1% 0.04% 2.54% 2.31% 1.68%
Short Term Treasury  SHY 0.0% 0.2% 1.27% 3.1% 1.41%
Treasury Bills SHV 0.03% 0.2% 1.0% 2.52% 1.07%
International Treasury BWX -0.47% -0.89% 0.3% -4.5% -0.54%

From the above trend table, all of bonds have done well for the past 3 months (13 weeks). Even though long bonds were weakened more in the last one week (and lower returns in the last one month), they still command higher trend scores than total bond market index (BND), at least for now. 

Municipal bonds are better than taxable bonds (for now)

We again are seeing that municipal bonds have had better returns than taxable bonds for the last one year (52 weeks): the 5.08% of MUB vs. 4.94% of BND. This is significant as the tax-equivalent yields of those municipal bonds will be much higher than those of their taxable equivalents. 

Municipal bonds have outperformed taxable bonds (as of 4/18/2019):
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR
Schwab Muni Bond Funds 1.8% 4.3% 3.2% 5.6% 6.7%
Schwab Total Return Bond 1.7% 1.7% 4.6% 3.4% 7.8%
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 2.4% 5.0% 2.1% 3.0% 4.0%
VBMFX (Vanguard Total Bond Market Index Inv) 2.4% 4.4% 1.5% 2.3% 3.5%

Again, the above are all nominal returns so the tax-equivalent returns of municipal bonds (and their portfolios) will be much higher. 

To summarize,  bonds are still adjusting to the recent economy. Inverted yield curve has been smoothened. Currently, among fixed income assets, long corporate bonds have highest score, indicating that investors are not much worried about credit quality as well as interest rates. It does again look like a goldilocks situation. Whether this can sustain or not is again a guessing game though. 

Market overview

US stocks continued to rise last week. In the meantime, US dollar has been strong, thus making developed market stocks and bonds relatively worse (US dollar denominated). US stocks are on the verge of breaking out of its previous high. For now, because of extended rise and expensive valuation, we call for cautions on risk assets including US stocks and REITs. Again, stay the course and manage risk accordingly. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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