For most of the last decade, fixed income has been hard to love, given record-low yields and mountains of negative yielding debt around the globe. But now, after an aggressive campaign of rate hikes from global central banks and one of the worst selloffs in bonds on record, we are learning to appreciate fixed income again.
Watch the recap with Debbie Fierro, CIO, Customized Bond Portfolios (CBP), Andrew Norelli, Portfolio Manager, JPM Income Fund and Core Plus Strategies, Vikas Pathani, Portfolio Manager, JPMorgan Preferred and Income Securities Fund, and Katie Ginsburg, Investment Specialist, to see the opportunities across fixed income:
VIDEO-0123-PB-1406544-Highlight Reel-2023-Februrary_Bonds-are-back-in-vogue-v6
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This call is timely because 2022 saw rapidly rising inflation and an extremely rapid rise in the Fed fund's rate-- the most rapid hiking cycle in four decades. The yield on the 10-year rose from 150 last January to above 4% at its peak. And fixed income markets sold off about 13%-- the worst year for the asset class on record.
With inflation now cooling and the Fed signaling that it's coming towards the end of its hiking cycle, we believe there's a compelling backdrop to invest in fixed income or grow fixed income allocations. Now, with that, I'd like to bring Andrew into the conversation. Andrew, can you talk through your view on what we can expect from the Fed in 2023, especially in light of the really strong employment report that we got last Friday?
The decision about T-bills or CDs or, ideally, short duration fixed income products, which yield a lot more than those other two options, is about what do we think the Fed will do? And it's versus cash. So it's not a decision, do I want to own long-term fixed income or short-term fixed income? It's short-term fixed income or cash.
And if you believe that the Fed is going to hike rates more than two more times, you should stay in money market funds in cash. If you think that two more times is appropriate, or less, then you're going to get a yield pickup going into short duration fixed income. So cash becomes king again. 2022 looks a lot like-- 2023 looks a lot like '22. That is not my view. Everything we can do quantitatively to assess what is likely to happen to inflation in the months to come suggests that inflation is likely to cool.
I just want to take one step back and just start with, what are clients looking for in municipal bond portfolios? And it's really simple. They're looking for safety, preservation of capital, and predictable stream of tax-exempt income.
Now, for the most part of 2020 into early 2022, when rates were near zero, munis were out of favor as they were yielding so little. And investors, rightfully, were going into other asset classes. However, as the Fed began to increase rates, munis became attractive again. So what are we currently recommending?
We're recommending the one to 17-year ladder. Why are we recommending the one to 17-year? Three reasons. First, I already mentioned-- it takes advantage of the most attractive part or the steepest part of the muni yield curve, which I mentioned was 11 to 15 years.
Second, it adds some duration. The duration of this portfolio has about 5.5 years. But most importantly, at some point-- and Andrew mentioned this-- at some point, we do believe the Fed will pause and start cutting rates. And so we want clients to lock into these higher yields for longer now.
And lastly, when you ladder out the maturities, you're taking the guessing game out of the interest rate environment. What I mean by that is you have choices each year. Interest rates are higher. Great, we reinvest those proceeds into the higher yielding market.
If interest rates are lower, you might decide, as bonds mature, I'm going to take the proceeds out and put my assets elsewhere. With the latter, there's a lot of flexibility. Traditionally, if you're in the highest tax bracket, muni bonds make more sense on an after-tax basis than treasuries, period.
So the best way to think about preferreds is as a hybrid security. We actually often call them hybrid securities. And the reason for that is it has both debt and equity-like features. So similar to debt, it has a fixed or floating rate coupon associated with it, and it has a set face value.
And then similar to equity, the payments can be deferred. So the majority of preferred securities are issued by investment grade issuers. And that's really important because that speaks to the high quality nature of them. On top of that, what we like about it is 75% of those companies are in highly regulated industries. So we're roughly around a 7% yield to worst.
So if you look back almost a decade, the range has been a little over 3%, which is kind of hard to believe today. It's a little over 8%. And really, that 8%-plus was seen in the fourth quarter of last year. So if you think about that, we're in the highs in terms of yields, which is similar to a few other asset classes out there. And even on a spread basis, we're still above the average spread that you saw during that same period.
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VIDEO-0123-PB-1406544-Highlight Reel-2023-Februrary_Bonds-are-back-in-vogue-v6
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Logo, J P Morgan, Private Bank. Disclaimer Text, The views and strategies described herein may not be suitable for all clients and are subject to investment risks. Certain opinions, estimates, investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice. This material should not be regarded as research or as a J P Morgan research report. The information contained herein should not be relied upon in isolation for the purpose of making an investment decision. More complete information is available, including product profiles, which discuss risks, benefits, liquidity and other matters of interest. For more information on any of the investment ideas and products illustrated herein, please contact your J P Morgan representative. Investment and insurance products. Not a deposit. Not F D I C insured. Not insured by any federal government agency. No bank guarantee. May lose value. Text, Highlights from, Bonds are back in vogue. How should you be positioned? How to position fixed income? Three panelists sit at a large glass top desk. Each have various sheets of papers in front of them. On the base of the table is a large facsimile of J P Morgan's signature. Text, Katie Ginsburg, Investment Specialist.
(SPEECH)
This call is timely because 2022 saw rapidly rising inflation and an extremely rapid rise in the Fed fund's rate-- the most rapid hiking cycle in four decades. The yield on the 10-year rose from 150 last January to above 4% at its peak. And fixed income markets sold off about 13%-- the worst year for the asset class on record.
With inflation now cooling and the Fed signaling that it's coming towards the end of its hiking cycle, we believe there's a compelling backdrop to invest in fixed income or grow fixed income allocations. Now,
(DESCRIPTION)
A split screen showing all three panelists and a Zoom window with a guest speaker.
(SPEECH)
with that, I'd like to bring Andrew into the conversation. Andrew, can you talk through your view on what we can expect from the Fed in 2023, especially in light of the really strong employment report that we got last Friday?
(DESCRIPTION)
Full screen of guest speaker. Text, Andrew Norelli, Portfolio Manager, J P M Income Fund and Core Plus Strategies. He sits in a furnished room with tall bookshelves behind him.
(SPEECH)
The decision about T-bills or CDs or, ideally, short duration fixed income products, which yield a lot more than those other two options, is about what do we think the Fed will do? And it's versus cash. So it's not a decision, do I want to own long-term fixed income or short-term fixed income? It's short-term fixed income or cash.
And if you believe that the Fed is going to hike rates more than two more times, you should stay in money market funds in cash. If you think that two more times is appropriate, or less, then you're going to get a yield pickup going into short duration fixed income. So cash becomes king again. 2022 looks a lot like-- 2023 looks a lot like '22. That is not my view.
(DESCRIPTION)
Fullscreen shows the three panelists listening to Andrew. Then back to fullscreen of Andrew.
(SPEECH)
Everything we can do quantitatively to assess what is likely to happen to inflation in the months to come suggests that inflation is likely to cool.
(DESCRIPTION)
Text, How to position portfolios in the muni market. The second panelist, seated center, speaks. Text, Debbie Fierro, C I O, Customized Bond Portfolios, parentheses, C B P.
(SPEECH)
I just want to take one step back and just start with, what are clients looking for in municipal bond portfolios? And it's really simple. They're looking for safety, preservation of capital, and predictable stream of tax-exempt income.
Now, for the most part of 2020 into early 2022, when rates were near zero, munis were out of favor as they were yielding so little. And investors, rightfully, were going into other asset classes. However, as the Fed began to increase rates, munis became attractive again. So what are we currently recommending?
We're recommending the one to 17-year ladder. Why are we recommending the one to 17-year? Three reasons. First, I already mentioned-- it takes advantage of the most attractive part or the steepest part of the muni yield curve, which I mentioned was 11 to 15 years.
Second, it adds some duration. The duration of this portfolio has about 5.5 years. But most importantly, at some point-- and Andrew mentioned this-- at some point, we do believe the Fed will pause and start cutting rates. And so we want clients to lock into these higher yields for longer now.
And lastly, when you ladder out the maturities, you're taking the guessing game out of the interest rate environment. What I mean by that is you have choices each year. Interest rates are higher. Great, we reinvest those proceeds into the higher yielding market.
(DESCRIPTION)
A split screen shows Andrew listening to Debbie.
(SPEECH)
If interest rates are lower, you might decide, as bonds mature, I'm going to take the proceeds out and put my assets elsewhere. With the latter, there's a lot of flexibility. Traditionally, if you're in the highest tax bracket, muni bonds make more sense on an after-tax basis than treasuries, period.
(DESCRIPTION)
Text, How to think about preferred securities. The third panelist speaks. Text, Vikas Pathani. Portfolio Manager. J P Morgan Preferred and Income Securities Fund.
(SPEECH)
So the best way to think about preferreds is as a hybrid security. We actually often call them hybrid securities. And the reason for that is it has both debt and equity-like features. So similar to debt, it has a fixed or floating rate coupon associated with it, and it has a set face value.
And then similar to equity, the payments can be deferred. So the majority of preferred securities are issued by investment grade issuers. And that's really important because that speaks to the high quality nature of them. On top of that, what we like about it is 75% of those companies are in highly regulated industries. So we're roughly around a 7% yield to worst.
So if you look back almost a decade, the range has been a little over 3%, which is kind of hard to believe today. It's a little over 8%. And really, that 8%-plus was seen in the fourth quarter of last year. So if you think about that, we're in the highs in terms of yields, which is similar to a few other asset classes out there. And even on a spread basis, we're still above the average spread that you saw during that same period.
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(DESCRIPTION)
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Here are the three key considerations from the conversation to help decide whether to bring bonds back into your life:
- Make sure you have a plan for your liquidity and that it is held in the appropriate vehicle.
- Core fixed income may offer a valuable ballast to portfolios and attractive income, but with yields falling, it may not last.
- Areas of extended credit, such as preferred equities, are attractive in the current environment and could offer equity-like returns.
For a deeper dive on how you can optimize your personal finances for 2023, watch the full webcast here
