SIMON BROWN: Your bond questions answered
In a high-yield environment you can’t ignore bonds. But you do need to understand the issues and challenges at play
The 10-year US Treasury yield hit the highest level since 2007 last week, offering a chunky 4.6% in dollars. This gives rise to all sorts of issues and challenges.
The first is: how do we get exposure to this yield? The second: can we buy US government debt?
The answer to the second question is no, not directly; you need to buy them in an exchange traded fund (ETF). This, then, answers the first question.
There are a few such ETFs listed on the JSE, or you can buy them on the New York Stock Exchange (NYSE). But the issue here is twofold. First, the risk of capital loss: if yields continue to move higher, the capital value decreases, as we’re buying in the secondary market. Second, many of these ETFs have lots of long-dated bonds that are at way lower levels. But the NYSE-listed GOVT has a yield of about 4.8%, while the BIL focuses on short-dated bonds, with monthly dividends and a similar yield.
On the JSE we have DCCUSD and DCCUS2 from FNB, ETFUSD from 1nvest and STXGBD from Satrix. Here, however, the historic yields are all below 3% — though they should improve in future payouts.
Overall higher yields are certainly attractive, but they will in time have a negative effect on equity prices
I also want to touch on the bigger issue about high yields on US debt. First, this will make some investors flock into the bond market after a decade or more of staying away because of low yields. This should, in theory, result in less money in equities and hence less upside for stocks.
The question is how long these higher yields last. It won’t be forever, but we’re not likely to see the almost 0% levels we did for much of the decade before the pandemic. The reality is that interest rates, and hence bond yields, need to normalise. Heck, we’ve had negative yields on trillions of bonds recently and that is totally not normal.
The second issue is that attractive US bond yields will result in money flowing into the dollar to buy these bonds, and that means a stronger dollar. We’ve already seen the dollar index rally about 7% in recent months — a huge move that’s resulted in all other currencies, including the rand, moving weaker. This trend will likely continue while yields are high.
A third, very important point is the effect of higher rates on equity valuations. Buying a stock is buying the future cash flows, and higher rates make those cash flows worth less — which makes the stock valuation lower. So far much of the market has largely looked past this, but the reality can’t be ignored forever.
So overall higher yields are certainly attractive, but they will in time have a negative effect on equity prices.
The solution here is the equity and bond portfolio. It could be the classic 60:40 equity-bond split, or whatever you decide works for you. But in a high-yield environment we can’t ignore bonds and only buy equities.
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