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  1. Home
  2. / Markets
  3. / Rates and Bonds

6 Top Tips for Income Investors in the Current Environment

From overweighting dividend stocks to avoiding high-yield bonds, this is how I'm playing things here.
By PETER TCHIR
May 15, 2018 | 03:30 PM EDT
Stocks quotes in this article: TLT, FLOT, FLRN, VZ, BCS

The S&P 500 is up almost 3% from its May 3 closing levels, while the 10-year U.S. Treasury yield is hovering near 3%. In light of those facts, it makes sense to run down my current income-investing recommendations, as well as what it would take for me to make any adjustments to them.

Here's my best current advice:

Overweight Dividend Stocks

I think the current rally in U.S. stocks will continue, as:

-- Earnings have been strong but not yet fully priced in.

-- Stock buybacks are starting to kick in.

-- The tone regarding U.S.-Chinese trade has shifted from negative to more positive and is becoming a potential catalyst that could take stocks higher.

-- We might see better-than-expected data as the full impact of tax cuts works its way into the U.S. economy.

-- Overall sentiment remains too cautious to me.

-- Geopolitical risk remains elevated, but will likely lead to more behind-the-scenes negotiations than to near-term hostilities.

I'd pay particularly close attention to dividend-paying U.S. bank stocks and energy plays, including master limited partnerships (MLPs).

Reduce Interest-Rate Risk

I expect the 10-year U.S. Treasury yield to break through 3% and eventually hit 3.25%.

As such, I recommend avoiding any income investments that rely on "duration" -- i.e., long-dated bonds -- to generate income. That includes the iShares 20+ Year Treasury Bond ETF (TLT) .

Decrease Credit Risk

High-yield bonds seem particularly fragile right now. They aren't cheap enough relative to other income opportunities, and they're showing signs that lack of price discovery represents a real risk.

The price performance from unexpected good news seems far too small relative to any downside performance that follows unexpected bad news. For example, bonds from WeWork Cos. -- a new issue that was so hot that underwriters increased the deal size -- continue to flounder.

Add Floating-Rate Risk

I really like floating-rate risk here. For example, the three-month London Inter Bank Offered Rate (LIBOR) -- the benchmark that most floating-rate bonds use -- is at 2.34% as I write this. That's historically high relative to other short-term rates like those of three-month U.S. Treasury bills.

Floating-rate bonds capture this. That's why institutional investors are adding floating-rate bonds where they can. In fact, floating-rate bonds have been the investment-grade market's best-performing segment for the past month.

If you're buying floating-rate bonds directly, look for companies that have lots of repatriated cash and won't be looking to issue more debt any time soon. Also look at banks' floating-rate debt.

Personally, I like longer-dated floating-rate bonds here. Yes, you face duration risk on your investment-grade credit risk, but I'm comfortable with that on floating-rate debt (just not on the interest-rate component).

Good choices here include ETFs that only buy maturities up to five years. These include the iShares Floating Rate Bond ETF ( (FLOT) , listed on the BATS exchange) and the SPDR Bloomberg Barclays Investment-Grade Floating-Rate ETF (FLRN) .

However, I'd really prefer a floating-rate mutual fund to an ETF. That way, a portfolio manager can be more aggressive on credit risk and buy some of the new, longer-dated floaters like those issued by Verizon (VZ) and Barclays (BCS) .

Buy Closed-End Funds

I continue to like (and own) some closed-end leveraged-loan fund, but am not adding here. There are some very interesting closed-end leveraged-loan fund run by Babson that have exposure to middle-market loans.

And while I'm worried about interest-rate risk, I want to identify closed-end municipal-bond funds that I'll look to buy at the right time. I'm finally seeing signs of some increased demand in these markets.

Other Sectors

I continue to like catastrophe bonds as a small part of a portfolio, although I might reduce exposure to funds specializing in them as we near the summer and talk of hurricane season.

I also like Chinese domestic bonds bought via ETFs for a small piece of your portfolio.

What Would Change My View?

As always, I'll revise the recommendations above if we get changing market conditions. For now, the two potential "bogeys" on my radar screen are:

-- Policy Risk. I'm worried about a possible Federal Reserve policy mistake, aided and abetted by the U.S. Treasury. I think the Fed's current pace of rate hikes is too fast, with today's flat yield curve scaring businesses away from investing for the future.

-- Geopolitical Risk. I think this is contained for now and might even create some positive surprises. However, the market is still susceptible to a shock on this front.

This article was originally sent to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this from Peter Tchir, Robert Powell, and many others.

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TAGS: Fixed income | Investing | Rates and Bonds | Markets | Treasury Bonds | ETFs | Funds | China | Bond Funds | Corporate Bonds | Credit Ratings | Dividends | How-to | Junk Bonds | Stocks

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