For over a decade, bonds offered a terrible value proposition as the Federal Reserve’s zero interest rate policy compressed yields, creating a major mismatch between opportunity and risk. Investors weren’t being compensated for the substantial interest rate risks that they were incurring. Remember, just two years ago, there were roughly $18 trillion in bonds that actually had negative yields, so borrowers were literally being paid to take on debt. This toxic cocktail of central bank manipulation has led to trillions in losses as rapid interest rate increases have devastated bond prices. Now in mid-2023, this selloff in bonds has created an enormous opportunity for investors to lock-in bond yields between 7-11% on relatively solid credits, at various maturities. This is a fantastic time for yield-hungry retirees, or near-retirees to lock-in an attractive income stream with less volatility than stocks.
We are finding quality bonds from highly profitable and financially strong companies, that were yielding 4-5.5% two years ago, which now are yielding between 7-11%. These are equity-like returns without incurring the same market-risks as simply investing in the stock market. To be clear, we are also finding great value in deeply undervalued stocks, as the market is highly bifurcated with huge spreads in valuations between growth and value stocks, but the opportunity to invest in bonds is the best in over 20 years and we are taking advantage of it. If we do get a recession, or even if we don’t, you can still see bonds get downgraded or decline in value, but the risks seem more than priced in for the most part. If the economy stays stable longer, recovers, of just doesn’t blow up, these bonds should perform very well. Even if the economy does weaken, that probably would lead the Federal Reserve to lower rates, which would make these higher-yielding bonds more valuable. A 7% yield-to-maturity bond could potentially return double-digits if we start to see some rate cuts over the next year or so. We are investing in some bonds that mature in less than a year, while other mature in 7-10 years, and just about everything in between. Keep in mind, we have been against just about all bonds for the last 13 years, but now the opportunity is just too good to pass up.
One thing I want you to think about is thinking of your investments as a business. Let’s say you have a mortgage yielding 4%, which for the most part the interest is probably tax deductible. If we can lock-in quality bonds yielding 8% to maturity, you are creating a very profitable spread between your investment income and cost of funds. Perhaps your money is sitting in a bank, and you likely won’t be needing it for the next 18-24 months. There are very safe investments such as Treasury bills and bonds with short-term maturities that can offer you a far better return than your savings account. While I don’t think the overall stock market is cheap by any means, we are finding immense opportunity in both value stocks and bonds.