Harvest capital gains: If it’s income you’re after, what better way to generate income than to harvest long-term capital gains in high yield bonds? The resulting potential “income” stream would accrue more favorable tax treatment than interest and would lock in gains at expensive levels. The alternative – letting your winners ride at a below 6% yield – seems like a risky proposition.
Rebuild your bond ballast: With yields on high yield bonds south of the 6% mark, I believe investors are no longer being sufficiently compensated for the risk they’re taking and I see limited opportunity for high yield price appreciation. While I remain neutral high yield, for investors concerned about “cracks in the foundation” or “the next shoe to drop,” now may be a good time to trim exposure and replace it with bond ballast, such as municipal bonds.
Employ alternatives: If higher interest rates were to undermine stocks, correlations between stocks and bonds would likely rise. With U.S. stocks fully valued and high yield bonds offering little value, liquid alternative structures that enable investors to go long and short a specific market, such as within equity and credit markets, would have the potential to outperform. Read more on this in BlackRock’s latest market outlook, and remember that while long/short strategies can be risky, they can also potentially offer a differentiated source of return in a well-rounded portfolio.
Buy volatility. With volatility as low as it is today, now would be a good time for investors to consider purchasing insurance in the event of a Federal Reserve (Fed)-induced market correction, as I suggested in a recent post.
Eventually, the Fed will normalize policy and the allure of using stocks as bonds and vice versa will fade. Until then, you’ll want to make sure you look under the hood – there may be a wolf disguised as grandma.
Sources: Linked to throughout Post, BlackRock research
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.
Kurt Reiman is a Global Investment Strategist at BlackRock who works directly with Russ Koesterich. He contributed to this post by providing research and investment insights.