The Answer to Whether You Should Buy Bonds Is: 'Are You Nuts'?

 | Dec 05, 2016 | 1:00 PM EST
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I was asked over the weekend if I thought it was time to buy bonds, since we have had such a selloff in the aftermath of the election. While there may be an opportunity to trade bonds for the short term here as I don't think that economic activity will rebound quickly enough to justify lower rates, I am not a great trader, so I will pass on that.

From a longer-term perspective, the answer would be a resounding "Are you nuts?" The 10-year Treasury is yielding just 2.37% -- hardly a rate where I want to be an aggressive buyer of bonds. 20-year high-grade corporate bonds are yielding right around 4%, while junk bonds are paying a whopping 6%. I want to get paid a lot more than that if I am going lock my money up into a bond investment.

Bonds are cheaper than they were, but I do not think we will see income investors return to the bond market to meet their investing needs anytime soon. Treasury and municipal yields are too low to generate significant income at current levels, and if I am going to take the risks of owning corporate bonds I might as well buy common or preferred stock.

The truth is that rates are going to remain low for some time, and even the incoming Secretary of the Treasury Steven Mnuchin thinks rates will stay low for a period before the economy is growing fast enough to justify permanently higher rates. In fact, the new administration is talking about locking in those rates for a long time by selling 50 and 100-year bonds to lock in low rates and keep interest expense down at the federal level. The Fed's monthly statements still contain lower-for-longer language, and I just don't see that changing anytime soon. Bonds will be worth buying someday, but today is not that day.

Why would I reach for yield in junk bonds when I could buy preferred shares issued by a company like Ares Management (ARES) , which will provide me a yield of 7% and trades around par? Arbor Realty (ABR) is one of my favorite REITs, and they have preferred stocks outstanding that will provide me a yield of over 8% right now. Arbor common shares are also yielding more than 8% at the current price; I would prefer owning those shares than a junk fund or ETF right now. I have been around long enough to know that when junk bonds sell off, there is a lot of money trying to climb out a little window, and prices can drop with devastating speed. There are still many choices in preferred stocks and REITs that I think have a much better risk-reward profile than corporate and junk bonds. If I was an income-seeking investor, I would focus my attention there, and not at the bond markets.

One segment of the fixed income market I am watching very closely is that of the closed-end municipal bond funds. We have seen some selling in the funds since the election, as investors are concerned about the possibility of higher rates and lower tax brackets that would make municipal bonds less attractive. As Doug Kass pointed out a few weeks ago, most closed-end muni funds use leverage, and their borrowing costs could go up when the Fed raises short-term rates later this month. It is not time to buy, but the funds are selling at higher than normal discounts to net asset value, and if the average discount continues to widen from the current 6% level towards the 10% discount we saw late in 2015, then it may be time for income investors to load up the truck in this asset class.

It is not the time to buy bonds. In truth, this is a good time to do absolutely nothing. Stocks are not broadly cheap, and the risk-reward profile of corporate bonds is horrible. Government bonds and municipals are not yielding enough to make it worthwhile to own them right now. The right strategy at the moment is to sit still, sell anything that is now selling at overly high multiples of asset value or earnings power, and hoard cash. If you must put money to work or just can't stand holding all that low-yield cash, then look towards REITs and preferred stocks. I think they are a much more lucrative and safe choice for income-seeking investors.

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