Coasting in Retirement Episode 21: Should investors pay attention to Bond Yields? Yes.
Segment 1 (Show Open):
Good afternoon, everyone! Welcome in. Welcome to Coasting in Retirement! That’s. Right. Thanks for joining us today, we’re excited to have you! I am your host, Josh Null, alongside co-host Michelle Lee Melton, back in studio after a short break to recuperate …Michelle, how are you? Well we are so good to have you back. Here we are once again in Coastal College’s recording studio, beautiful downtown Fairhope, hatching up another great show for those of you tuning in!
Listeners: Michelle and I are here today to discuss financial topics relevant to those of you in or near retirement living your best life along our part of the gulf coast. If you’re just tuning in to our show, welcome, you’re listening to Lower Alabama’s most dynamic financial radio show. Here’s what we’ve got in store for you today: First segment – deep dive on our topic of the day. 2nd segment - at about 20 minutes past the hour - fan favorite, “Michelle with the News of the Week”. 3rd segment, roughly 40 minutes past the hour, ”Josh’s Crystal Ball and…(Michelle:) Big Mouth”. That’s right, big mouth. So buckle up, we’ve got a lot to get to!
Quick background on me for those new to the show. Again, my name is Josh Null, I am a fee-based financial advisor, I hold my FINRA Series 65 securities license, and I am the owner of Gulf Coast Financial Advisors, an independent investment management and financial planning firm with offices in Fairhope and Orange Beach, Alabama. You can find more information on me and Gulf Coast Financial Advisors by visiting our website gulfcoastfa.com, or feel free to give us a call at 251-327-2124. If you missed that, don’t worry, we will repeat our contact info several times throughout the show!
Listeners, every know and then we have a topic that just can’t fit into one episode. That is the case today. So we welcome you to Part 1 of a 2 part series where we tackle what is happening in the bond market and it’s broader impact on the likelihood of a recession. We will kick off part 1 with a discussion about bonds and bond yields, something that has been all over the news lately, but it’s a topic that I think a lot of people don’t fully understand, including a lot of people in my industry. Heck, it even confuses me at times, and this is what I do for a living! Then savvy listeners will recognize bond yields as a way to discuss the “inverted yield curve”, which historically is a leading indicator of a looming recession, a topic we’ll tackle in our next episode.
Investors that read financial news have undoubtably noticed recent headlines like “bond yields hit multi decade high” and “the bond yield curve has inverted, which is a leading indicator of a coming recession”. Why should those of you in or near retirement pay attention to bond yields? We’re going to attempt to answer this question. But first, let’s start with the back story and some context to the basic math of bond yields.
Let’s start with defining bonds and how they differ from equities. Very simply put, a bond is a debt instrument issued by either governmental institutions or corporations to raise money for something they want to invest in. If you buy a bond, you are loaning these institutions a set amount of money, at a set coupon rate, which is fancy way of saying the interest promised you in return for your loan, for a set period of time, called duration or bond maturity. Michelle, you have experience in municipal bonds correct? What would be one example of why a city issues a municipal bond?
As compared to equities, bonds are not a piece of ownership in the underlying company or government institution. If you want to own a piece of Apple, Inc, you buy a share of stock in them. If you want to loan Apple, Inc money in exchange for interest, you buy a bond issued by them. Got it? Good. Now, listeners, there are a couple of terms I want you to remember when it comes to bonds. First is face value, also known as par value, which is the amount the bond is worth when it’s issued. Most bonds are issued at a face value of $1000. Next is the coupon rate, which we already stated is the interest paid on the bond. This usually doesn’t change after the bond is issued- both coupon and par terms don’t change much across the bond market, in that what you see in writing is what you are to expect. What does change, and the reason for this episode, is yield and price. Yield is a measure of interest that takes into account a bond’s fluctuating value. Wait, I thought you said most bond’s face value is $1000 Josh? That is correct, the face value is usually $1000, but bonds can vary in price, or current value, which is what the bond would sell for on the secondary market after being issued. It’s these last 2 terms – price and yield – that are the reason a normally boring topic such as bonds are all over the news lately. Why is that? Let’s do a little history lesson and use a silly example to explain.
Historically, bond money is often referred to as “smart money” when compared to equities. Why would that be? The thinking is that savvy investors and traders sometimes prefer the certainty of the interest paid on bonds, that bonds help remove some of the volatility in your investment portfolio, and if the underlying issuer, generally speaking a corporation, were to get into financial trouble, bond holders stand in line ahead of stockholders for repayment of capital. Let’s take that statement piece by piece so that you investors understand why, what has historically been a pretty steady eddy market, experienced it’s worst year EVER in 2022, and are still front and center in so many financial news stories.
First – volatility – Michelle’s favorite word – how much an investment fluctuates in value. Historically bonds values, remember – prices on the secondary market – don’t fluctuate much because, again historically, interest rates set by the Fed tend to be pretty stable. Unless you’ve been living on a rock, you all know that interest rates have not been steady lately, in fact, we’ve experienced one of the fastest rate hikes in our economies history. OK, Josh, but why does that lead to volatility in bond prices? Let’s pivot back to yield and price with a fun example:
Michelle, I’m a corporation, call me Josh, Inc., and I want to invest in a boat because I think it will improve the bottom line of my company’s revenue, so I issue “Josh, Inc. Bonds” and sell a bond to you for $1000. In exchange, I promise to pay you 3% interest over 5 years. Sound good? Now fast forward 6 months. Interest rates have risen, and I can’t find any more suckers to finance my boat at 3% interest, so I start issuing bonds at a 6% coupon rate, or interest rate. So now you’re sitting on the Josh, Inc. boat stewing about the measly 3% interest you’re receiving when all the party goers around you are getting 6%. You get so stewed that you decide you want to sell your Josh, Inc. bond and move on. What happened to the price of your bond? Is it still worth $1000? That’s correct, it no longer is worth $1000 because there are better options out there offering higher interest. Let’s say the price of your bond has fallen to $975. That means, if you want to sell your bond, you’re selling at a discount, and as a result, and when you sell at a discount, your yield increases because yield moves inversely with bond prices. The higher the interest offerings go on new bonds, the higher the yields get on the overall bond market because investors demand more yield when buying lower interest paying bonds. And this silly example is what happened to bond holders all across the bond market. Rapidly increased interest rates resulted in discounted bonds, particularly hitting long term bonds locked in at now low rates, resulting in a high yield environment – and for existing bond holders that want or need to get out of their discounted bonds, this sucks - that is what is causing all of the commotion among bonds.
Now if this was only issue bond holders were dealing with, it would be one thing. Probably wouldn’t be an issue that was all over the news and leading many people to forecast a recession. But there’s something else at play. Remember when I mentioned an inverted yield curve at the beginning of the show, Michelle? Simply put, an inverted yield curve is when short term bonds have a greater yield than long term bonds. It means that investors plan on earning less on bonds they hold for a longer term…which is means investors think the economy is heading south and the Fed will have to cut rates. What has led to this?
For the last 18th months, ever since the Fed started hiking rates around March of 2022, the 2-year bond yield has been fairly accurate in predicting where the Fed was heading with rate increases. The problem, and the reason for the inverted yield curve, is that the long end of bond rates had to be dragged along. 20-30 year treasuries, even 10 year treasuries, have lagged the short term bonds. Normally, short term rates should not be significantly higher than long term rates. Fortunately, that curve is now normalizing as long term bond rates catch up, but the damage to investors’ outlook has been there, resulting in a general flight from equities into relatively high interest, short term debt instruments, such as money market funds.
Plain English, please Josh. High rates are causing turmoil in certain areas of the market. For example, if you can buy a 6-month T-bill yielding north of 5%, why would I buy a utility stock only yielding 3%? Remember the Josh, Inc. bond example? Investors are opting for high rates with lower volatility.
What does this mean to retail investors? Well, for long term bond holders, it means you’ve felt as much price pain as you’ve probably ever experienced in your investing career. For those of you with a heavy bond portfolio, we have systems and software to do an MRI of your positions and present you with a game plan. We recently did a case analysis on a large municipal bond position and the results were very enlightening. It also means that the death of the 50/50 or 60/40 portfolio has been overstated. That is, 60% equities and 40% bonds, or 50/50, or 70/30 – whatever example you want to use where bonds are part of your investment mix. Here’s why:
There’s no magic formula that always predicts stock prices. But one thing is heavily correlated. The relationship between starting yields of a bond portfolio and the future returns. (https://www.pureportfolios.com/starting-yield-and-future-bond-returns/#:~:text=Starting%20Yield%20%26%20Future%20Returns&text=Historically%2C%20the%20higher%20the%20starting,better%20future%20returns%20for%20bonds.&text=The%20above%20graph%20shows%20there's,Index%2C%201976%20%E2%80%93%202021).) If starting yields for long duration bonds are around 5%, there is an extremely high chance that your returns over a 10-year period will around 5%. It’s lumpy, not consistent, and there’s volatility. It’s been shown that starting yields dictate forward returns. So 60/40 makes as much sense right now as it ever has. For example, if you buy into a mixed portfolio with long term treasuries sitting at 4.5%, there’s a high likelihood that total return will be 4.5 over a 10-year period. It’s not exact, just a likelihood. Contrast this to just a few years ago when you bought bonds to decrease volatility, but the returns were almost nothing.
Listeners, while I think it’s important that you understand the math behind what is happening in your portfolio, and there’s absolutely nothing wrong with the DIY approach, this stuff is in our blood, and we feel we provide good value for helping your navigate your financial goals and dreams. So on that note if you want to have a no pressure, free, no obligation conversation with us, reach out via the website gulfcoastfa.com, or simply call 251-327-2124. Repeat.
Alright folks, coming up next! Every week Michelle and I scour the interwebs for helpful financial articles related to our topic of the day, especially articles that pertain to those in or near retirement. Join us after the break to hear Michelle and I discuss this week’s relevant headlines in our “Michelle with the News of the Week” segment. Don’t turn that dial!
Segment 2 - Michelle with the News of the Week:
Josh: “Welcome back to Coasting in Retirement, your host Josh Null here! As we discussed before the break, every week Michelle and I scour the interwebs for helpful financial articles related to our topic of the day, especially articles that pertain to those in or near retirement. Our job is to help you all understand how these headlines impact you, especially when it comes to your money! So, without further adieu, here’s “Michelle with the news of the week!”:
1. Michelle: Alright Josh, let’s start with Yahoo Finance. They have a recent headline titled “The 5% Bond Market Means Pain is Heading Everyone’s Way”. This article gave me pain just reading it. First, it talked about how 30 year Treasury bond yields punched thru 5% this past week for the first time since 2007, and why the Treasury bond yield impacts everything from car loans to mortgages to cost of public borrowing. It also quoted an analyst that compared what to is happening to the bond market to the dot.com bust, saying that bond investors are going to have to accept that “we’re not going back to what was true the last 10 years” of cheap money. I mostly stayed awake during your explanation of bond yields in the first segment, so can you please tell me how much “pain” we have headed our way because of high bond yields?
2. Michelle: Next up, CNN Business fills us in on “Here’s why investors are selling bonds in droves”. This article reinforces a topic we’ve discussed on this show, that “bond prices cratered in 2022 after the Fed began drastically raising near-zero rates to tame runaway inflation”, which triggered a steep selloff in bonds…which I know understand resulted in a lower, discounted price for bonds and higher yield. All this math! This article also quoted a bond analyst as saying that “Next year, you’re going to have to think about fundamentals that are going to support a larger allocation to fixed income”. OK Josh, what’s this mean in plain English, and what are you overall thoughts on this article?
3. Michelle: Let’s pivot to Reuters. Oh look, another joyful headline to give to your listeners: “Bear steepening US yield curve dashes ‘soft landing’ hopes”. I will say that despite the less than encouraging headline, this article does state that from an economic perspective, there is a certain irony at play - long-dated yields are soaring partly because incoming data suggests the economy is far more resilient than most observers, including Federal Reserve policymakers, had expected. But it also references a deteriorating U.S. fiscal picture, rising new debt issuance and investors demanding a higher 'term premium’ on long term debt as factors leading to the inverted yield curve. So Josh, what exactly do they mean when they say “soft landing” and what is your opinion on where we are headed based on this data?
4. Michelle: Last article. Actually, it’s what I think would be called more of a “white paper” than a news article. The source comes from the “Municipal Securities Rulemaking Board” which I learned is a United States based self-regulatory financial organization that writes investor protection rules and other rules regulating broker-dealers and banks in the municipal securities market. They have a downloadable white paper simply titled “What to Expect When Selling Municipal Bonds Before Maturity”. So I am going to be honest Josh, while this article appears to have a lot of great info, including many things we touched on in this episode, I did not read the whole thing nor do I intend to ever read all of it, but I did catch a section titled “tax implications of selling your bond before maturity” and I recall you discussing this recently, so the floor is yours:
Josh: Michelle, great job as always with the headlines, these are all important pieces of information that impacts those in or near retirement! Listeners – if you have questions around the topics in our headlines of the week, or questions related to your investment strategy or financial plan, you can set an appointment by calling us at 251-327-2124 or by clicking calendy link on our website, gulfcoastfa.com. It’s in the upper right-hand corner. It’s a free, no pressure, no obligation meeting.
Alright folks, coming up next : Josh’s Crystal Ball and Big Mouth. What have been some of my predictions? Have I been right? Was I ever wrong? How wrong? What do I think is going to affect investors in the near future? We talk about all of these things and poke a little fun at my big mouth. Stay tuned!
Segment 3 – Josh’s Crystal Ball and Big Mouth:
Welcome back! Your host Josh Null here, along side co-host Michelle Lee. So, I am opinionated, I have strong opinions at times, I would say a radio show host that isn’t probably wouldn’t be very interesting to listen to. And I am paid in my profession to offer professional guidance and opinions to my clients, otherwise what use am I? Sometimes I feel so strongly about something that I talk about it publicly, on the various podcasts and radio shows I’ve had, sometimes I’ll even make predictions, and while I usually proved right, there are times I swing and I miss. Want to hear me beat my chest or maybe…eat a little crow? Then let’s get at with Josh’s Crystal Ball and Big Mouth. Alright Michelle, what’s first?
1. Michelle: Alright Josh, at the beginning of 2023, you predicted that the stock market would be in “scratch and claw” mode to capture gains, that volatility would continue and that many investors would make “flight to safety” decisions with their portfolios. With the recent market downturn wiping out a lot of the year-to-date gains and the market still experiencing occasional significant swings, what are you seeing with your clients, and was your crystal ball right?
Josh: So first let’s define what investments are considered “safer” investments, at least compared to equities: CDs, money market funds, annuities, treasuries, and historically, bonds. Annuities are on pace for their highest sales totals EVER in 2023, while the total amount of capital in money market funds recently $5.71M. The market has rebounded recently and if you are in this for the long run, the occasional overselling of stocks presents an opportunity to possibly find a long term discount. The wild card has been bonds – people are selling off their long term bonds and looking for newer bonds - because the general investment community has finally come to grips that rates are going to be high for longer than expected, which means yields will have upward pressure, which means their bond prices will continue to have downward price pressure. For folks in or near retirement, or just a low risk tolerance, there absolutely has been a flight to safety. Listeners – if you have a damaged bond portfolio or are just uncomfortable with your portfolio, we can take a look, call 251-327-2124.
2. Michelle: Next up Josh, you’ve stated multiple times that annuity salespeople play too heavy on investors’ fears of losing money, and that while these products often have a place with capital preservation with some upside potential and income production, all to often they were sold as a “golden ticket” type of financial product. We just mentioned that annuity sales are on pace for a record sales year in 2023 so obviously the annuity story is resonating with a lot of investors. What’s your big mouth got to say now?
Josh: Be honest that you use annuities, and why. The main reason I got frustrated about the high pressure annuity sales pitch is because for years the market was doing fine, with out a lot of volatility, and interest rates were low. Well, that’s all out the window now, has been for the past 12 months and it appears that it will be this way for a while, so this plays right into the annuity story. Describe the different types of annuities and how current market conditions and interest rates make them appealing: MYGAs, Deferred Income Annuities and SPIAs, and FIAs. Insurance companies can be more generous when their fixed income portfolios are producing a lot of accrued interest.
3. Michelle: Last one Josh, the gift that keeps on giving. On our July 17th episode of Coasting in Retirement, you asked the question “Is this as good as it gets in regard to fixed interest investments”? Rates jumped almost immediately after that episode, and lookee here, it appears that rates on fixed interest investments have jumped AGAIN across the board. So we already know that your big fat mouth spoke too soon, but care to update us on what you’re seeing for interest rate offerings on the fixed rate investments that you can offer your clients?
Josh: have MYGA rates ready (5.75%!!!), bank CDs, and money market funds.
Well listeners, I hoped you enjoyed a peak behind the curtain on how I form my opinions and predictions, and more importantly, that I’m willing to admit when I am wrong. Which isn’t very often, but still. Now, to our listeners that have more questions the various investments and topics we discussed in this segment, we invite you to reach out to us. Call us anytime at 251-327-2124 to make an appointment or find us at on our website at gulfcoastfa.com.
Folks, that’s it for us this week here at Coasting in Retirement! I want to give a huge thank you to my lovely co-host, Michelle Lee Melton, a thank you to our awesome radio station 106.5, many thanks to the provider of our show music, local band Sloth Racer, and as always my sincere appreciation for all of your out there that have been listening and joining us on this journey. We would love to be a part of your journey as well. Until we talk again next Sunday, have a wonderful and productive week. This has been Coasting in Retirement with Josh Null!
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