With Marilyn Cohen, Founder and CEO of Envision Capital Management, Inc., Los Angeles fixed-income money manager
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Bond Market Outlook 2017
Bond expert, author, and CEO Marilyn Cohen joins Steve to talk about bonds, interest rates, and related topics, and her bond market outlook for 2017. The conversation begins with a brief recollection of the double-digit interest rate environment of the 1980s and the observation that, compared to that time, rates today are “next to nothing”.
Returning to the present, Steve asks Marilyn if she expects higher rates this year, given recent increases and guidance by the Federal Reserve and the possibility of inflationary stimulus spending by the new Trump administration. Marilyn is not convinced that rates will rise to a game-changing level for most bondholders, though she admits that if rates do go higher than she expects (more than 1-1.5% in a short time span), it would be very bad for long-term bonds and many bond ETFs (exchange traded funds). The strategies she recommends to her own bond investor clients are based on buying shorter-term individual bonds with maturities of 3 to 9 years out. These bond purchases are often laddered, which entails buying bonds of different maturity dates in order to minimize interest rate risks, increase liquidity (ease of sale), and diversify credit risk. In a rising interest rate scenario, as these bonds reach maturity, their returns are reinvested in newer, higher-yield securities. This is the ideal outcome, according to Marilyn.
Bond ETFs vs Individual Bonds
While buying an individual bond is essentially offering a loan to some entity—whether Federal, corporate, municipal, overseas, etc.—this loan has an interest rate (yield) and a date (maturity) at which it must be paid off in full. Like many other types of loans, there is always the possibility that the borrower goes bankrupt and the loan is never repaid. Bond ETFs have grown in popularity in recent years, and there are some crucial differences between owning individual bonds and investing in a bond ETF. On a basic level, bond ETFs offer access to a portfolio of bonds (which is what the fund consists of) without the ownership of individual bond issues. With ETFs, there is no maturity date upon which a bond is redeemed for its original face value. Instead, the gain or loss, measured against the price paid for a share of the ETF (which is based on the underlying net asset value of the fund) is realized when the individual sells his shares.
Marilyn warns investors about some of the unique risks inherent to many ETFs. Because the value of their portfolios is influenced by the buying and selling of its shares, bond ETFs have more volatility in both their yield and the net asset value of their portfolios. For those who are fearful of rising interest rates, Marilyn remains convinced that owning individual bonds of near to mid-term maturities offers a safeguard against that risk.
Steve brings up the fact that there are new bond ETFs which offer advantages that address these problems. There are now funds called target term funds which have specific maturity dates of varying length. This allows investors to take the bond ladder approach by buying ETFs with successive maturities, just like with individual bonds. Furthermore, there are ETFs which act as “closed funds” that do not constantly buy and sell bonds from their portfolio, a trait which makes them more stable. Marilyn concurs that these funds are a much better substitute for directly owning individual bonds than older bond funds. She recommends studying the fund portfolio to make sure that management is staying on target with its maturity targets.
Marilyn brings up another alternative to both ETFs and individual bonds: high yield and investment grade hedged funds. These can pay between 5 and 6% yield in the first case and up to 3% in the latter. These should be especially attractive to investors who expect interest rates to rise for an extended period of time. Marilyn again points out that, regardless of exactly how much interest rates rise, investors are going to need new strategies for 2017 and beyond.
Bond Market Forecast 2017
Revisiting her 2017 bond market outlook, Steve steers the conversation to the credit cycle and its potential end and the Fed’s interest rate policy going forward. Marilyn believes she’s in the minority because she expects only a modest rise in rates from the Fed this year. She thinks the 10-year treasury could trade in a new, higher range, breaking out from the current 2.38% to a range defined as 2.5% on the low end to 3.25% at the upper end. When interest rates and bond yields are viewed over the span of decades, 3-5% is the historic norm, a perspective that ought to temper fears about the macro effects of a 1% bump in rates.
While she argues that both the credit cycle and the decades-long bull market in bonds are coming to an end, she doesn’t see rates “inflating with a vengeance” anytime soon. In part, the strong demand from foreign investors chasing yield for US bonds (government and corporate) will act to keep yields down.
Marilyn Cohen will be speaking on Never-Never Land: Sponsored by Central Banks on February 8th and February 9th on Brace for Impact: The Credit Cycle Is Ending, and Let The Bond Autopsy Begin at the MoneyShow Orlando. You may register for free here.
Steve Pomeranz will be speaking on February 10th on Myth Busting Your Way to Riches, covering myths such as how a simple investment in the wonderful S&P 500, may actually turn into a disaster for most investors and other investing delusions that prevent you from becoming rich.
For more information on the MoneyShow Orlando and to register for free, click here.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: Marilyn Cohen is a leading bond manager and expert in fixed income. She’s written The Bond column in Forbes magazine and is author of four books, most recently, The Little Bond eBooklet: Must-Knows About Your Bond Portfolio, which I’ve read and I’m telling you is must-reading for anyone who is managing their own bond portfolio, and she just told me, and I’m sure she’ll tell me again that you can get it for free at smashwords.com. Also, Marilyn will be speaking at the MoneyShow Orlando on February 8th. Her talk is entitled Never Never Land: Sponsored By The Central Banks, and she talks twice on February 9th, the first being Brace for Impact: The Credit Cycle is Ending, and Let the Bond Autopsy Begin.
I too will be speaking at the show as well on February 10th. My topic will be Myth Busting Your Way to Riches, where, for example, I’ll discuss how a simple investment in the wonderful S&P 500 may actually turn into a disaster for most investors, and I’ll discuss these and other investing delusions that prevent you from becoming rich. You can register for free to see and hear all the terrific speakers at orlandomoneyshow.com, or find out more about it at stevepomeranz.com.
Having said all that, let’s get to our guest and welcome Marilyn Cohen. Hey, Marilyn, welcome.
Marilyn Cohen: Thank you so much, Steve.
Steve Pomeranz: You are a bond expert, and I got into the investment world in 1981, and I think interest rates were just a little bit higher when I entered into the bond market.
Marilyn Cohen: Just a smidge.
Steve Pomeranz: Just a little higher, like about what?—1300 basis points higher, meaning that rates were 15%. I got great stories about all that we can share sometime. I’m sure you do too. Right now, interest rates are kind of next to nothing. They’re kind of following inflation, at best, but the big fear right now is that with the new president and the stimulus that’s coming on next year and the fact that the Fed is starting to raise rates in a small fashion in the short-term part of the bond market, what’s going to happen with interest rates next year? What does that mean to me as a bond buyer? Should I be getting out of the bond market or stay in?
Marilyn Cohen: Well, this is a multiple-choice question that you just gave me. First of all, what does it mean as a bond investor? It means that if all of the bond gurus and the economists that are yelling, “Rates are going higher! Rates are going higher,” if they end up being right—which I think is doubtful—then people that are in long-term bond funds and long-term exchange traded funds are going to get really hurt. They will lose much more than people that are in short bond funds, hedge-bond funds, and they will certainly lose more than people that have individual bonds with final maturity that are, like, 3 to 9 years. So having said that, people got so happy over the last few years as interest rates continued to drift down, and they saw the value of their bond funds increase and their bond portfolio increase, but, Steve, you can’t spend total return. That’s what total return means, the income plus the appreciation or depreciation, so I, for one, will embrace higher yields because the majority of our clients own individual bonds, laddered maturities, not too long-term, so as those bonds mature and roll down the yield curve—which means get closer and closer to maturity—I’m hoping, fingers crossed, that I’m going to be able to take that money and reinvest at higher yields. That’s what bond investing is all about.
Steve Pomeranz: Okay, cool, so I got that, but let’s bring it back a little bit. Now, when we talk about bonds, let’s get down to a little bit of the details here. A person can go out and buy an individual bond (which basically means you’re lending money to some institution or some municipality) and they say, “We’re going to pay you X interest rate and we’re going to give you your bond, your money back at maturity.” That’s basically what it is, it’s a loan. Now, you’re saying, basically, if you owned an individual bond, and let’s say you’re getting 3%, you’re going to capture your 3% every year and then, at maturity, you’re going to get your money back, so …
Marilyn Cohen: Assuming the company or the issuer’s still in business.
Steve Pomeranz: Yeah, stays in business, yeah, which is kind of important. Yeah, but assuming that they’re doing that, so the fluctuations up or the fluctuations down don’t really mean anything, but many investors these days are not buying individual bonds. They’re buying bond funds. They’re buying ETFs, which also buy individual bonds, so they’re buying these things that are proxies for the ownership of individual bonds, and they don’t really feel or see the fact that at some time in the future they’re going to get their money back, so I guess …
Marilyn Cohen: They won’t unless they sell. That’s very clear and that’s when I said, Steve, you know, a couple minutes ago, they will lose more if rates move up, and I don’t mean a quarter of a point or half a point, but 1% very quickly and then another 50 or 100 basis points. They will lose more than those people who have the individual securities.
Steve Pomeranz: Marilyn, let me ask you this question. Even though I may not own the individual bond where I can say, “Hey, I own Jacksonville Electric Power Authority and it pays me a certain interest rate and it matures,” the bond fund that I buy that owns the Jacksonville Electric will experience a maturity of that bond and collect the coupon at the same time, so, in the long run, won’t the net effect be the same?
Marilyn Cohen: Not even close and that’s because that fund or that exchange trader’s fund—the Jacksonville Electric is one, only one of hundreds—and you’ve got people panicking and getting out, where the bond fund manager has to sell not matter what’s going on and people that are euphoric and come in, and you have an inflow of cash, and the yield that you thought you were going to get declines, although on the other side of the ledger you see an increase in the net asset value, so it’s not equitable. It is very different.
Now, I understand that bond funds, ETFs, etc., are the big paradigm shift away from individual securities. Individual securities are a heck of a lot more work than just pointing and clicking and buying an ETF, but if one is really afraid of higher rates, then perhaps they should shift their paradigm and include some individual securities with maturities so they can count on that money coming due.
Steve Pomeranz: Right. Now, there are new ETFs out on the market, these exchange-traded funds, which actually have set maturities, so you can buy one that matures in 2018, 19, 20 and so on. In a sense, you can ladder—using this terminology of buying bonds with successive maturities— you can ladder them with ETFs and those are closed, so there’s not money going in and money going out. Would that be a fair substitute?
Marilyn Cohen: That certainly is a great substitute. You just have to look under the hood when you’re looking at, and most of those are called target term funds and they have them in municipals and in corporates. You just have to make sure that the fund manager isn’t deviating from the maturity, the finite maturity. A lot of times they’ll buy bonds that are 2 and 3 and 4 years longer saying, “Oh, well, I’ll just sell them a couple months before,” but, overall, Steve, I think that it’s really a very good alternative, and you’ve got even another alternative that you can go into, and those are there are a group of high yield and investment grade hedged funds that, if they’re high yield, they’re paying somewhere in the 4s and 5s—although the interest rate is hedged and if they’re investment grade—they’re paying anywhere between 130 to maybe 3%, so I just want one of the takeaways from our conversation to be, if you are an investor listening, and you think interest rates are going to spike up and stay up for a long period of time, then you shouldn’t continue to invest like you’ve been doing last year and the year before, and the year before that.
Steve Pomeranz: Yeah, because interest rates have been coming down. The longer the maturity on your bond, the better off you were. Now, it’s the reverse is going to happen, so, Marilyn, and, by the way, I’m speaking with Marilyn Cohen. She’s a leading bond manager and expert in fixed income, journalist, writes a column for Forbes magazine, author of many books, knows what she is talking about. So you think we’re at the end of this downward credit cycle where rates have been dropping since the 1980s when I got into the business. How far up do you see them going, Marilyn?
Marilyn Cohen: I am of the minority opinion that I think that we’re just going into a higher trading range yield-wise. I don’t think we’re going to reflate with a vengeance. I don’t think rates are going to hell in a hand basket. I think we go into higher trading range, 2 1/2 maybe on the low end of the 10 year. Maybe we go to 3 or we breach 3 to 3 1/4% but, in our experience, because I started out in 1979 in bomb land, that isn’t a big deal. I think that the bond bull market is over. It’s probably long in the tooth, and we will go into higher rates but not, nothing like ‘81, nothing like ‘89, nothing like 1994.
Steve Pomeranz: Yeah, well, when you look at a long-term chart of interest rates—and I actually just happened to be looking at one the other day that went back to the 1800s—and what you see is a line that’s really around the 3 to 5% rate, and then you have this huge spike in 1981, and then it’s steadily declining, and now we’re back to that 3 to 5% range, as a matter of fact, I love to listen to old time radio on Sirius, and they have ads for US Government bonds, during the war and it’s like, “Get 3% in a US Government bond,” and I remember thinking like a dozen years ago I would have laughed at that and said how ridiculous it is to get 3% on a bond. Now, it’s like, “Oh, that’s right. That’s kind of normal.”
Marilyn Cohen: Exactly. That’s exactly right. We may someday go back up to those high yields like we saw in 1981 and 1989 and 1994 but I don’t think you and I will be alive because those are long cycle moves and that would mean reflation globally with a vengeance. Don’t forget we still have a lot of negative global yields and where does money flow? It always flows to the highest yield, so I think that the US is going to continue to attract more money into treasuries, agencies, corporates, and then those foreign investors get a double brass ring. They’ll not only get higher yield but they continue to reap the benefits of a stronger dollar.
Steve Pomeranz: Stronger dollar too and then so all that buying will keep a cap, perhaps, on interest rates just going higher and higher and higher.
Marilyn Cohen: Exactly.
Steve Pomeranz: Okay. My guest, Marilyn Cohen. Well, unfortunately, we’re out of time. Leading bond manager, expert on fixed income, and she’ll be speaking at the Money Show Orlando on February 8th and February 9th, and, of course, I will be speaking there as well on February 10th. You can find out all about it at orlandomoneyshow.com or just come to my site, stevepomeranz.com. Marilyn, let’s have you back on again. We’ll talk about more things bonds, okay?
Marilyn Cohen: My pleasure.
