As 2020 draws to an end, we cannot help but to reflect on experiences of the last year and start to make predictions for the year to come. In the credit markets, we have witnessed extreme volatility in March and have since seen a rebound with bond prices soaring to highs, while yields remain at historic lows. The welcome news of a possible vaccine(s) and rebounding U.S economy offer a ray of hope that 2021 will not only be the start of a new year but a new business cycle as well. We foresee a brighter picture overall, but not without its challenges.
Low interest rates are likely to remain a key challenge for fixed income investors. As you may know, last year the Fed slashed interest rates. This has pushed the yield on short term investments to near zero. Longer term rates are off lows but remain suppressed. We believe that as the economy continues to rebound, we will see a rise in longer term rates. However, short term rates will remain anchored near zero until the Fed raises rates, which will most likely be in 2023.
What does this mean for investors seeking income? The challenge to find yield on high quality debt instruments will continue. We believe during low interest rate cycles, investors should consider “fixed income alternatives” to help generate income similar to what the bond market has provided in the past. Below we explore two alternative sources of income:
Real Estate Investment Trusts (REITs) allow you to access the real estate investment market while having the benefit of daily liquidity. We purchase publicly traded REITs which trade on exchanges and offer monthly dividend payments.
Demand for utilities typically remain the same regardless of the economic cycle. Utility stocks tend to have less volatility than other equities and their dividends can offer reliable sources of income.
The above “fixed income alternatives” will be coupled with our existing strategies of purchasing investment grade bonds, preferred stock and select high yield positions. We will be adding exposure to these alternatives thoughtfully and they will only be a small portion of your overall total fixed income. These investments offer yield with generally lower volatility than equity markets, however, they have increased risks when compared to traditional fixed income instruments.
Please respond to this email with “opt out” if you would prefer not to own these “fixed Income alternatives”. If your portfolio is intended to be fully invested in stocks these investments may not be part of the portfolio.
It is important to remember that interest rates are part of a cycle. We are currently at the bottom of that cycle. Rates will eventually tick back up as we have breakthroughs on the virus containment and economic growth resumes, which will benefit both stock and bond investors. In the meantime, we may continue using select exchange traded funds (ETFs) as a place holder for a portion of your funds. We view these ETF’s as an opportunity to earn yield as more opportunities become available in individual bonds.
We are optimistically looking forward to 2021! We hope you and your family have a safe and healthy holiday season.
All of us on the team thank you for your continued vote of confidence during this extraordinary year and we are grateful for the opportunity to be the stewards of your wealth. If you have experienced any significant changes in your financial position or have any questions about our work, please feel free to contact us.
Your Team at Main Street Research
Our Founder James Demmert was recently published in US News. If you wanted to read more please click here.