Over the past 60 days, CPI topped 9% before easing somewhat, the US Federal Reserve hiked short-term interest rates by three-quarters of a percentage point and promised more hikes, home rents continued to rise by double digits, and much more. You could feel the fixed income markets explode in a bonfire for the ages.
Not correct. Instead, since June we have witnessed a remarkable bond rally. That makes sense and could stay.
With economic growth slowing (or remaining negative) and falling oil and other commodity prices permeating the economy, there is no reason for medium and long-term interest rates to remain high. The Fed’s statements and rate hikes are intended to dampen inflation. This rally tells us that markets are expecting persistently lower inflation sooner rather than later.
Accordingly, the yield on a 10-year government bond fell from 3.5% on June 14 to as low as 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) corporations and tax-paying municipalities, for example, have gained (or regained) even more. How can that be, with all the fear of stagflation compounded by the strident politics of this election year? And how should we manage our yield-seeking dollars?
Don’t put them all on the bench at first. Banks don’t follow the Fed’s rates up the ladder. And bonds are safe as long as you are paid on time and in full. There are no worrying credit problems, bank failures, mass foreclosures, or other echoes of the financial crisis. Second, although bond and bond fund capital values fell earlier this year, this allowed vigilant bond fund portfolio managers to accumulate assets with higher coupons and increase their cash distributions. This is visible across all categories, maturities and credit ratings.
Take the Vanguard GNMA Investor Fund (VFIIX). $0.00824 was paid out in January. Annualizing that and dividing it by its NAV of $10.54 (at the time) gives a return of about 0.94%. In August, the same fund distributed $0.02103, more than double, at a NAV of $9.89 (vs. a low of $9.36 on June 14). The current yield is 2.5% and the total return from June 14th to August 5th is 4.6%. As mortgage rates begin to fall, this should give the NAV a little more boost as fixed rate mortgage pools become more valuable until lending rates fall enough to unleash massive new refinancing. This will take a while.
Turn to Dodge & Cox income (DODIX), a solid core fund that holds blended high-grade bonds. It pays quarterly and issued $0.057 per share at $14.05 NAV in December 2021, for a 1.6% yield. After falling to $12.44, the fund has rallied to $12.90, paying $0.077 for a 2.4% return.
Switch to high yield bonds, look at that Fidelity Capital & Income Fund (FAGIX). After losing 15% earlier this year, the fund halved that loss in a matter of weeks while regularly increasing its monthly distribution; based on the last payout, its return is up to 4.3%, after the start of the year just over 3%.
These are three funds that I know many of you own and have long served investors well. I could quote hundreds of others. Abandoning proven investments in a mild economic downturn and a couple of weak quarters is short-sighted.
#bond #funds #build #summer #rally Source
