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posted on 14 December 2016

Don't Wait To Lock In Bond Yields

by Richard Stavros

Investing Daily Article of the Week

As yields on government and corporate bonds start to rise, I'm reminded of the Silicon Valley venture capitalist saying, known as Kleiner's Law of Appetizers: "The time to eat the hors d'oeuvres is when they're being passed round." In other words, seize cash as soon as it's offered.

That's valuable advice today for income investors. Don't take higher yields for granted because there's no guarantee they'll continue going up into next year and beyond.

The increase in bond yields (and decline in bond prices; they move opposite of each other) has been based on the market's belief that the incoming Trump administration's stimulus policies of tax cuts, deregulation and infrastructure spending will create growth and push up inflation, which in turn leads to increased yields.

But the stimulus plans are still largely a mystery, and their impact won't be felt until 2018. So there's no way to know whether such policies will spur growth. And adding to the ambiguity is past stimulus efforts haven't spurred business investment and spending.

In fact, corporate investment as a proportion of GDP has continued to decline. Said Martin Sorrell, the CEO of WPP plc, a British multinational:

"Businesses are choosing to return funds to shareholders rather than invest them back into their operations. Yet there is no shortage of cash to invest. Companies are estimated to be sitting on more than $7 trillion of cash worldwide - a form of corporate inertia that will continue into 2017 and beyond."

Sorrell pins the reason corporations are not spending on "deep scars on the collective corporate psyche" from the 2008 financial crisis which he believes has "fundamentally changed the attitude to risk of an entire generation of executives." He doubts Trump's policies will heal the scars.

And if growth forecasts are wrong in a year, we know that rates will be headed lower. According to a Wall Street Journal story, a firm called Macroeconomic Advisers developed a financial model that looked at what happens if Treasury yields rise further, not because of an improving economy but because investors believe, based on an incorrect growth forecast or for whatever reason, that the Federal Reserve will raise rates more aggressively.

The analysis concluded that if growth doesn't pick up and current trends persist, and if 10-year Treasury yields rise by another half-a-percentage point, "then the simulation predicts that annual economic growth by the first quarter of 2018 would fall to just 0.9%," a startling result that would likely force the Federal Reserve to cut rates again.

So, don't count on growth and higher rates. And next year if you can buy safe income investments paying higher rates, do it. If growth does return and inflation moves upward, there will be plenty of time to re-position your portfolio.

If you need some guidance on bonds to buy, we'll be giving some names in Personal Finance. We have started studying which fixed income investments have more attractive yields due to the recent sell off in bonds, and which companies have started to issue bonds with higher coupons.

In the coming months, we will be developing a bond portfolio to complement our equity income portfolio and advise investors on new fixed income investment strategies and opportunities.

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