Long-term interest rates in the U.S. have tumbled to lows never seen before as concerns about the economic impact of the coronavirus outbreak mount. And the Federal Reserve may cut short-term rates more in the coming months. What’s an investor to do?
The yield on the 10-year Treasury dipped below 0.7% for the first time on Friday. Rates are falling as investors buy bonds and push up their prices – which move in the opposite direction of yields – as they hunt for “safer” places to put their money. The deadly coronavirus, investors warn, could strangle supply chains and keep shoppers at home. If that worry plays out, it will shrink economic growth and corporate profits, putting a hoped-for global recovery on hold.
And borrowing rates could fall further. The Fed already surprised markets by lowering its key interest rate by half a percentage point on March 3. Federal-funds futures, which traders use to bet on the path of central bank policy, showed Friday that investors were betting there was a 100% chance the Fed would cut interest rates again at its March 17-18 meeting, according to CME Group data. Traders were also betting on subsequent rate cuts in April and June.
Spring homebuying:Hello bidding wars: Home sellers gain edge in this year’s housing market
The low-rate world presents an opportunity for investors to adjust their portfolios in a bid to boost returns as well as protect against risks.
The reason: The level of interest rates affects how certain investments, ranging from stocks to bonds to real estate, perform.
In general, low rates during good economic times are good news for stocks. Why? It reduces the borrowing costs of corporate America, boosts risk-taking, borrowing and economic activity, and makes all the cash companies earn now worth more in the future.
But there’s also a time when falling rates foreshadow risks on the horizon: when the Fed is cutting rates to combat a slowdown. And, with the coronavirus disrupting manufacturing supply chains and curtailing consumer activity and spending in virus-affected areas, today’s lower rates poses a tricky challenge.
Investors must weigh whether any epidemic-related slowdown will persist or if the coronavirus will ultimately be contained. If the impact is limited, that could spur shoppers and travelers to get back to their normal routines, paving the way for a V-shaped rebound driven by pent-up consumer demand. Some Wall Street pros have compared the coronavirus outbreak to the temporary shock and business slowdown caused by the 9/11 terror attacks.
Here are some ways to tweak your portfolio in a falling-rate environment, focusing on how to weather a major market disruption like the coronavirus.
Even though plunging yields on 10-year Treasurys mean the price of those bonds are getting more expensive and your interest payments shrink, investing in U.S. government bonds pretty much guarantees you will get your principal or initial investment back.
And Treasurys, which are viewed as a core holding in portfolios, are less volatile, less risky and less prone to big losses than riskier assets, such as stocks or lower-rated corporate bonds that pay higher yields. The broad U.S. stock market, for example, has declined more than 13% from its Feb. 19 record high.
“In fixed income, the primary role of core bonds is to diversify portfolios,” says Bill Merz, head of fixed income at U.S. Bank Wealth Management. “We can begin seeking out higher-yielding bonds only after we ensure the portfolio ballast is adequate.”
Investors in search of higher yields, of course, can purchase high-yield corporate bonds (or junk bonds), “but they come at the expense of higher risk,” especially at a time when corporate debt levels are high, Merz adds. “We are currently neutral on high-yield corporate debt.”
Buy quality dividend-paying stocks
You don’t want to simply go out and buy stocks with the highest yields, as those companies might be weaker financially and more apt to cut their dividends in tough times.
What you want to buy are high-quality stocks of companies that not only have enough cash on hand and future cash flow to ride out an economic storm but also have a history of increasing their dividend payouts each year, says Jay Sommariva, vice president and director of fixed income at Fort Pitt Capital Group.
“Looking at historical dividend payers without decreases is a good place to start,” Sommariva says. But he notes that even these types of stocks are subject to large price drops in tough market environments, such as the panic-induced selloffs sparked by the coronavirus outbreak.
As of early February, 64 companies in the S&P 500 have increased their dividend payouts to shareholders for 25 consecutive years or more, according to S&P Dow Jones Indices. These “dividend aristocrats” include members of the Dow Jones industrial average, such as 3M, Coca-Cola, Johnson & Johnson, Procter & Gamble and Walmart.
While tech stocks are new to the dividend-paying game, some tied to long-term growth trends, such as Big Data and digital communications, also offer plump yields without the risk of a dividend cut, says Matt Burdett, manager of Thornburg Investment Income Builder Fund. He cites Broadcom, a semiconductor and infrastructure software company, as an example.
“Broadcom is priced at a discount but is tied to the secular growth of more data and communications driving its cash flow,” Burdett says.
Buy coronavirus rebound candidates
You should also consider buying the dip caused by the coronavirus stock market sell-off, says Bryce Doty, senior portfolio manager and senior vice president at Sit Fixed Income Advisors.
It might seem scary with stocks in the travel and tourism industry suffering huge declines, but investors should “be open to buying bonds beat up due to the coronavirus, such as Royal Caribbean bonds or some of the airlines’ bonds (and) … other companies in the leisure and energy sectors,” Doty says. “Even buying Apple on dips caused by a couple of bad quarters might be something to consider.”
Other rebound candidates include energy companies. Big U.S. oil companies, like “dividend aristocrats” Chevron and Exxon Mobil, offer “near-record yields with financial profiles that improved over the years,” says Thornburg’s Burdett. “This will come into view once we emerge from the current end-market weakness and impact of coronavirus.”
Other big tech stocks that pay a fatter dividend than you can get on a 10-year Treasury include Apple, Microsoft, Intel, Cisco Systems and Qualcomm.
Buy assets less tethered to the economy
Another way to play falling rates is to invest in assets whose success is not closely intertwined with the economy. Reinsurance, or insurers that provide policies to other insurers, is a good example, says Merz of U.S. Bank Wealth Management.
“Reinsurance is one area that can be appealing and can generate incremental yield,” Merz says. “Returns are correlated to weather patterns more so than the economic cycle. So, it provides compelling portfolio diversification as well.”