Yields are rallying. Years ago, that was a sardonic observation on the bond market—that is, bonds are falling due to the ineluctable inverse relationship between their prices and yields. The higher future interest income from new purchases of fixed-income securities was scant compensation for the principal losses on previous holdings, however.
At some point, yields had rallied so much and prices had become so depressed that bonds became a buy. Have we reached that point again, with a benchmark 10-year Treasury yield near 4.5%, a level not seen since 2007?
A few investment pros think so, pointing to yields that have climbed decisively above inflation. Others demur, however, noting the risk of further yield increases (and price declines) isn’t worth it, especially when significantly higher returns are readily available on risk-free short-term instruments such as Treasury bills. The 5.5% yields on those Treasuries also present a high hurdle for risk assets such as stocks and speculative-grade corporate credits.
Among those favoring longer bonds is Chris Brightman, chief executive and chief investment officer of Research Affiliates. Real yields—that is, their margin above inflation—are the highest since the 2008-09 financial crisis, he notes.
This past Thursday, 10-year Treasury inflation-protected securities, or TIPS, traded at 2.112%, the highest real yield since mid-March 2009, according to Tradeweb data. The flip side is that the
iShares TIPS Bond
exchange-traded fund (ticker: TIP), traded that day at its lowest price since April 14, 2010, according to Dow Jones’ data keepers.
iShares 20+ Year Treasury Bond
ETF (TLT) traded Thursday at its lowest level since April 12, 2011. For bond bulls like Brightman, this is an opportunity to buy low.
Conversely, Brightman is bearish on the big U.S. growth stocks, but not because of the higher yields that make their valuations less compelling. Brightman thinks the rapid growth in earnings for the likes of
(NVDA) cannot be sustained to justify their stock prices.
Some other investment pros look askance at buying 10-year Treasuries at nearly 4.5%, instead of short-term T-bills yielding a full percentage point more. Only if one thinks bond yields will drop can one justify taking on more risk for less current reward, says Jeff Muhlenkamp, the second-generation portfolio manager at Muhlenkamp & Co. and the
Charles Lieberman, chief investment officer at Advisors Capital Management and a veteran Fed watcher, says rates of 5.5% on the short end of the market act as a magnet to draw yields on longer maturities higher. So why take the risk?, he asks rhetorically.
Those high short-term rates also raise the bar on all other alternatives, Muhlenkamp says. What interests him is energy, for a couple of reasons. Firstly, he observes that crude oil prices have been rising into the $90-a-barrel range in tandem with the dollar’s rally since midsummer. Usually, commodities such as oil move in the opposite direction of the greenback. That suggests petroleum is in a long-term bull market, the result of years of underinvestment in the sector and environmental constraints on boosting output.
Unlike the previous beneficiaries such as domestic producers of shale oil, Muhlenkamp favors offshore beneficiaries, including
(SLB), formerly known as Schlumberger. He’s also positive on
(EQT), a gas producer. If an emphasis on high-yielding short-term paper and energy sounds like a page from the inflationary 1970s, that’s not a coincidence.
Higher interest rates make stocks trading at elevated price/earnings multiples vulnerable, Lieberman adds. Also at risk are traditional defensive sectors such as utilities and consumer staples, which he sees trading at excessive valuations resulting from their perceived stability.
But that leaves pockets of “tremendous value,” Lieberman says. Despite rising interest rates, he favors housing-related stocks due to the overwhelming shortage of existing housing supply, which is unlikely to be corrected for a number of years. His picks include well-known names such as
(PHM), and small-cap
For higher yields from fixed income, Lieberman likes business development companies, or BDCs. These are nonbank lenders to riskier, smaller businesses, but with eye-popping yields around 10% to compensate. Among his picks are leading names in the sector, such as
Sixth Street Specialty Lending
Another yield pick: real estate investment trusts investing in nursing-home properties. The sector was battered during the Covid pandemic but has since recovered. Lieberman’s picks include
Sabra Healthcare REIT
Omega Healthcare Investors
(OHI). Yields range from around 7% to nearly 9%.
Finally, for a bondlike play with an equity kicker, Lieberman likes Bank of America’s 7.25% convertible preferred shares (BAC.PL). This is what’s called a “busted convertible” since the preferred is exchangeable for
common stock (BAC) at $50 a share, far above Thursday’s close of $28.05. While the embedded call option is far out of the money, the yield is an attractive 6.41% at the preferred’s price of $1,130.50, a premium over the face value of $1,000 a share.
While yields on Treasury bonds are rallying, they could go still higher, making for better opportunities elsewhere.
Write to Randall W. Forsyth at firstname.lastname@example.org