Key Takeaways
- Investment-grade bonds, US Treasury securities, high-yield bonds, floating-rate loans, and stocks of gold miners are among the income investments that may offer opportunities in the second half of 2023.
- Investing in a wide variety of assets may help investors meet their needs for income despite the increasing potential for an economic slowdown.
- In exchange for higher income, some assets may experience more volatility than traditional income investments.
If inflation doesn’t slow down more, we may see a recession forming. As of May 2023, CPI was at 4% – down from almost 5% in April 2023. History makes a strong case for high-quality bonds in an economic downturn. In every recession since 1950, bonds have delivered higher returns than stocks and cash. That’s partly because the Federal Reserve and other central banks have often cut interest rates in hopes of stimulating economic activity during a recession. Rate cuts typically cause bond yields to fall and bond prices to rise.
Investment-grade bonds, US Treasury securities, high-yield bonds, floating-rate loans, and stocks of gold miners are among the income investments that may offer opportunities in the second half of 2023.
Market conditions constantly change and the investments that deliver the highest returns today may not be the ones that do so next month or next year. Investment-grade bonds of high-quality companies can provide an alternative to owning those companies’ stocks in an economic environment where bond prices have historically risen, and stock prices have fallen. Right now, bond interest payments—known as coupons—on many investment-grade bonds are also higher than they have been in recent years. Those coupon payments, as well as their prices in the marketplace, contribute to the total return of these bonds.
Keep in mind that the bond universe is a far vaster and more variegated place than the stock market and not all bonds perform equally well during recessions. Right now, attractive investment-grade bonds are those issued by utility companies, master limited partnerships that operate oil and gas infrastructure, and big US money-center banks. Some of these fixed- and floating-rate bonds are paying current yields of 6% or 7%, are trading at a discount. A few years ago, you’d need to look to bonds issued by companies with much lower credit ratings to get those types of yields.
Opportunities in high yield bonds
While a potential economic slowdown might seem to raise risks that non-investment-grade bonds could default, high-yield bonds are available that offer current yields in the high single digits without excessive risk. In a diversified portfolio, those high yields could potentially offset declines in asset prices that often accompany economic slowdowns.
High-yield bond yields are now exceeding the rate of inflation and you may get a ‘a bigger bang for your buck’ in high-yield bonds than stocks of the same companies. If earnings decline, high-yield bond prices are likely to be less volatile than stock prices. High-yield is also attractive because more than 50% of the market is currently rated just below investment-grade and presents relatively little credit risk. It’s unusual in a good way that there are no sectors of the high-yield market that have higher levels of risk right now. Even if the economy gets worse, you could still earn close to 10% on high yield with much less volatility than stocks.
Opportunities in longer-term Treasurys
Besides investment-grade corporate bonds, government bonds such as US Treasurys have historically delivered higher returns during recessions than stocks or high-yield corporate bonds. For months, uncertainty about the lifting of the US federal debt ceiling had raised questions about the Treasury market but a bipartisan agreement to suspend the debt ceiling has allayed those worries and Treasurys are once again considered among the safest investment options.
In addition to the safety that comes from being backed by the full faith and credit of the federal government, Treasurys with maturities of 5 to 10 years may also present an attractive opportunity for return from both their relatively high current coupon yields and from a potential rise in their prices when the economy turns down and takes interest rates with it. If the economy slows, inflation slows, and the Fed eventually cuts rates, there may be opportunities with 5-, 7-, or 10-year Treasurys, not only earning 3.75% or 4% coupon yield but also to start making total return higher as the rates move lower and the prices of Treasurys in the market rise.
All is not lost for stocks
While stocks have historically underperformed during recessions, the stocks of companies that mine gold could provide an unexpected source of opportunities if economic growth and interest rates come down in the second half of the year.
Gold has long been popular with investors who are concerned about the power of inflation to reduce the value of cash and other investments, but owning it also comes with risks. Gold miners’ earnings have historically grown when demand has risen, as it often has in times when economic growth has been weak and real yields decline along with interest rates. Goldminers typically distribute a significant portion of those earnings to shareholders in the form of dividends.
And let’s not forget our old favorite, mutual funds
Multi-Asset Income Funds invest in a wide variety of income-oriented assets and seek returns that are comparable to what stocks have historically delivered, but with much less volatility than stocks, which have historically struggled during recessions. No matter where we are in the business cycle, these funds do more with less ~ meaning stock-like returns, with less stocks and less volatility.
These funds seek high quality assets whose prices have been temporarily pushed down by investors overreacting to uncertainty about factors unrelated to the ability of the assets to deliver yield to the investor who holds them. Given widespread anxiety about where the economy may be headed, that means this can be a good time look for these mispriced assets.