by Bryan Perry

March 10, 2020

So much for living through one’s Golden Years off of a portfolio driven by yields in fixed-income assets! Anything with a maturity date and an investment grade is seeing its yield crash. The flight to safety is causing Treasury yields to fall to levels never seen before. There is genuine panic in the bond market in a world awash in sovereign liquidity that wants to own U.S. Treasuries – no matter what the maturities.

Take a look at the rapid rate declines across the U.S. Treasury maturity spectrum last week:

Rapid Rate Declines

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Investment grade corporate bonds are also in the midst of a herculean rally, as the 10-year chart of the widely traded iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) clearly shows (below). The current yield on LQD is 3.11%, with a 2.32% yield to maturity. This is an ETF with $33 billion in assets, 1,985 separate holdings, and an average duration of 9.45 years that pays monthly – all that some investors want – a simple, safe ETF paying 3% and experiencing a firehose of capital inflows.

Investment Grade Corporate Bonds Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Granted, when the stock market finally settles down, shares of LQD may retreat by 5% to 7%, but don’t count on that happening anytime soon. The bond market operates out of fear.

Anything outside Treasuries and investment grade corporate debt is under severe stress – even investment grade preferred shares paying around 5% are seeing spreads widen out and share prices starting to buckle. This class of security has seen a real nice bonus yield of a couple points over the investment grade corporate bond market, but has since “lost that loving feeling,” at least as of last week.

Standard and Poor's 500 Preferred Stock Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Where there is serious hand wringing and gnashing of teeth is within the junk bond space, where spreads are starting to blow out. From the 5-year chart below, we can see how the current sell-off in high-yield debt is starting to resemble the corrections in the first quarter of 2016 and the fourth quarter of 2018.

High Yield Junk Bonds Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For the time being, the recent price deterioration might be construed as just another garden variety correction that will right itself over the near-term. But with Saudi Arabia officially sparking a new all-out oil war that is crushing oil prices, debt-heavy energy companies are now on serious “default watch.”

The fallout of the OPEC+ meeting last Friday is going to send a lot of leveraged oil and gas companies into bankruptcy. This wave of yet-to-be-determined number of junk bond blowups will impact the broader junk bond market that now stands at over $1.5 trillion in issued paper, up from $700 billion in 2007.

For all of 2019, the default rate in the junk bond market was only 1.9%, well below the historical average of 3.3%, according to Deloitte. During the recovery from the Great Recession, the portion of the market made up of investment grade bonds fell to 78.6%, down from around 90% in the previous two recoveries.

The double whammy of the coronavirus bringing stress to global supply chains and the latest oil price war puts the junk bond market on high alert. Though I personally believe this sector, like the overall market, will eventually recover when the number of COVID-19 cases plateaus, this won’t be true for junk debt in the energy patch. There is real trouble brewing and investors with exposure in the energy sector that is not blue-chip should consider lightening up ASAP. I’m well aware that energy stocks have been severely punished, but they could become even more volatile, which will be reflected in bond and stock instability.

Junk Bond Default Rates Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The ground has shifted greatly under the markets, with high-quality yields in fast decline and valuations for low-quality debt sliding hard – so what can income investors do to compensate for this volatility?

Sell some out-of-the-money covered calls on blue-chip stocks and put the market’s volatility to good use.

Most investors I’ve talked to are content to ride out the coronavirus correction, but there will certainly be a hit to earnings, because the situation is still highly fluid. As a result, option premiums have expanded big time in the current market, both in puts and calls.

Case in point: Shares of MasterCard (MA) are trading 60 points off their recent all-time high of $347.25, and yet investors can sell the $350 Calls for June for over $500 per contract. Do I think MasterCard shares will rally when the virus fears start to subside? Of course. Do I think the stock is going to trade above $350 to a new all-time high by the June 19 expiration to where the stock gets called away? Nope.  

Navellier & Associates does not own LQD, HYG, MA in managed accounts or a sub-advised mutual fund.  Bryan Perry does not own LQD, HYG, MA in private accounts.

Buying Treasuries and investment grade debt after this torrid runup is fraught with risk, when the good news surrounding the virus eventually crosses the tape. Why not use these 1,000-point rallies to bank some volatility wherever and whenever possible? After all, selling covered calls is just another name for “free money.” And if we’re going to wait out this wild trading range, we might as well get paid to watch.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

Global Mail by Ivan Martchev
With Saudi Help, Oil is Headed into the $20s

Sector Spotlight by Jason Bodner
History Indicates the Market Could Bottom Around March 20

View Full Archive
Read Past Issues Here

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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