LOOK TO BONDS FOR AN ALTERNATIVE TO STOCK MARKET NOW / BARRON´S MAGAZINE

Look to Bonds for an Alternative to the Stock Market Now

By Randall W. Forsyth

Real estate investment trusts focused on healthcare are one way to play rising interest rates. Here, an LTC Properties assisted-living facility in Medford, Ore./ Courtesy LTC Properties

Return with us to ancient times, when dinosaurs ruled, at least in technology terms. 

It was early 2007, when Blackberries were in everybody’s mitts and the first iPhone hadn’t yet gone on sale, let alone changed the tech world. 

This distant era was the last in which you could earn 5% on a U.S. Treasury bill. 

Until now.

Five percent is a risk-free rate far above what anyone under the age of 40 likely is accustomed to. 

Following the 2008-09 financial crisis, T-bill yields hugged zero percentmost of the time, except for a move into the 2% range by 2018. 

They plunged anew when the Covid-19 pandemic erupted in 2020.

Starting last year, however, they began to climb, as the Federal Reserve sharply raised its short-term interest-rate target by 4.25 percentage points, to 4.50%-4.75%. 

And with two more quarter-point hikes likely in March and May, and possibly a third in June, T-bills due in six months topped the 5% mark this past week for the first time since April 2007, according to the St. Louis Fed.

The rise in short-term money-market yields has significant implications beyond letting savers earn a decent return again.

A 5% yield with zero volatility risk sets a very high bar for the stock market, observed Peter Oppenheimer, chief global equity strategist at Goldman Sachs Asset Management, in a webinar this past week. 

That’s especially true with the S&P 500SPX –0.28%  trading at a price/earnings multiple of 18.5 times—well above its 20-year average of 15.

So Douglas Kass, head of Seabreeze Partners Management, has bidden goodbye to TINA (There Is No Alternative to equities) and said hello to TATA (Treasuries Are the Alternative). 

In fact, T-bills are providing roughly three times the S&P 500 dividend yield of 1.65%, according to Peter Boockvar, chief investment officer at Bleakley Advisory Group.

Given the yield gap, David Kotok, Cumberland Advisors’ chairman and chief investment officer, says he has a very high 25% cash position in his clients’ portfolios of exchange-traded equity funds.

What’s more, investment-grade corporate bonds now offer the smallest extra yield margin ever compared with three-month T-bills, which were offering 4.80% on Thursday, Lotfi Karoui, Goldman Sachs Asset Management’s chief credit strategist, said on the unit’s webinar.

In comparison, the iShares iBoxx $ Investment Grade Corporate BondLQD +0.39%  exchange-traded fund (ticker: LQD) had a 30-day SEC yield of 5.02%, according to sponsor BlackRock, with greater credit and interest-rate risk.

Given these developments, James Kochan, a former fixed-income strategist at Merrill Lynch and Wells Fargo and adjunct faculty member at the University of Wisconsin-Milwaukee business school, recommends that investors stick to one- to two-year Treasuries and one- to five-year Treasury inflation-protected securities. 

The latter should continue to benefit from sizable increases in the consumer price index, he writes in an email. 

The Vanguard Short-Term Inflation-Protected SecuritiesVTIP +0.04%  ETF (VTIP) and the iShares 0-5 Year TIPS BondSTIP –0.01%  ETF (STIP) are large, low-cost funds in the sector.

Further out on the risk scale, Kochan likes shorter-term high-yield funds, given that any defaults in this group should be limited by the economy “doing well enough.” 

Two other ETFs—the iShares 0-5 Year High Yield Corporate BondSHYG +0.41%  (SHYG) and the SPDR Bloomberg Short Term High Yield Bond (SJNK) are shorter versions of the major high-yield bond ETFs. 

But in this sector, GSAM’s Karoui would avoid leveraged loans. 

While their floating rates might boost returns, they pose an increasing burden on borrowers at a time when their revenue could be squeezed—a recipe for disaster.

As for municipal bonds, one of Barron’s income picks for 2023, they have rallied strongly since the turn of the year. 

That’s the good news. 

The bad news is that their prices have climbed, lowering yields for anyone buying now. 

With 10-year AAA-rated tax-free bonds’ yields equaling only 65% of comparable Treasuries’, Kochan would avoid munis. 

A 75% ratio would represent fair value, he says.

But longer-term munis, with yields of 4.50% for mid-investment-grade credits, are still attractive, says John Mousseau, CEO at Cumberland Advisors. 

That would be equivalent to approximately a 7% taxable yield for an investor in the 35% bracket, far above the federally taxable 3.90% yield on a 30-year Treasury. 

And he sees further Fed rate hikes resulting in a negatively sloped yield curve (with short maturities above longer ones), ultimately hitting stocks and sparking a large rally in bonds.

Strong Economic Data Weaken the Case for Continued Stock Rally

In contrast, Charles Lieberman, chief investment officer at Advisors Capital Management, thinks that rates will head higher. 

He prefers maintaining shorter durations for clients and favors real estate investment trusts with exposure to healthcare. 

Lieberman’s picks include Medical Properties Trust (MPW), Omega Healthcare Investors (OHI), Sabra Healthcare (SBRA), and LTC Properties (LTC). 

Their yields range from around 6% to more than 9%.

For the near term, Treasury bills yielding upward of 5%, with no risk and exempt from state and local income taxes, still are tough to beat. 

Even if they offer all the excitement of a flip phone.

Corrections & Amplifications

David Kotok is chairman and chief investment officer of Cumberland Advisors; an earlier version of this article erroneously referred to him as CEO.

John Mousseau is CEO of Cumberland Advisors; he was misidentified as head of fixed income, his previous title, in an earlier version of this article.