This is the way the expansion ends, “not with a bang but a whimper.”[1] Though T.S. Eliot’s oft-quoted poem isn’t actually about our economic expansion, its final line does ring true in this case. As we mentioned in our last letter, this interest rate cycle has been a wimp itself, so it is no surprise we are whimpering our way back down the rate chart now. For bond investors seeking higher yields, this unfortunately means it started raining again just as we were starting to dry off.
The adjustments in interest rates, however small, did manage to affect a few numbers in our bond portfolios this summer. We saw an uptick in interest coupon rates as the Fed started cutting, thanks to the inverse-floating rate bonds. We also had an increase in prepayment speeds, likely an effect of the summer home-selling season. Prepayments increase cash flow, and in the case of discounted bonds, help increase overall yield. As we all know, cash (or more specifically, cash flow) is king, as that helps make a portfolio malleable in any environment without having to sell securities.
Still, with the Fed Funds rate inching its way back under 2%, and having been sitting in this puddle for more than a decade, we are watching yields slowly erode. Thankfully, many older bonds in our portfolios are helping to prop up yields. Mortgage-backed securities (MBS) continue to offer the best combination of yield and security, in our opinion. Most AAA rated corporate bonds are yielding under 3%. In fact, you’d likely have to go all the way to a BBB rating before getting anything above 4%, taking on much more credit risk than we’d like. The stock market of course offers a wild ride of huge gains and huge losses on subsequent days.
The MBS market is relatively quiet these days, as most investors are holding tight to their bond portfolios. We continue to seek out opportunities to bolster yields in accounts. Current MBS offerings yield 3-5% depending on specific characteristics. The higher yielding pieces are harder to find and in high demand, but we have been able to snap some up in the last few months. In some cases, we may look to other markets, like dividend stocks and Master Limited Partnerships (MLPs), as ways to add yield in this environment. We will likely be contacting you over the next few weeks to discuss options for your account, as they adhere to your objectives and risk tolerance.
Our focus remains on capital preservation and long-term growth. It seems we are well positioned for these goals in the current environment. With so many variables at play, both domestically and globally, it is an especially good time to be invested in securities backed by real assets with real values.
Copyright Cooper Capital, Inc. 2019
This information is not intended to be used as the only basis for investment decisions, nor should it be construed as advice designed to meet your particular needs. You are advised to seek the advice of your financial adviser, legal or tax professional, prior to making any investment decision based on any specific information contained herein.
[1] TS Eliot “The Hollow Men” 1925
