By Kevin Flanagan, Head of Fixed Income Strategy; Scott Welch, CIMA, Chief Investment Officer – Model Portfolios
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“Well, Jane, it just goes to show you, it’s always something—you never can tell. If it’s not one thing, it’s another.”
(“Roseanne Roseannadanna,” played by Gilda Radner, Saturday Night Live, 1977–1980)
The Evolution of Rates, Spreads and Yields
Let’s begin this blog post with a graph we used in a blog post from last June, highlighting the historical disparity between the S&P 500 Index dividend yield and the 10-Year Treasury note yield:
At that time, we made the argument that investors seeking to optimize current income out of their portfolios were better off over-allocating to yield-focused equities than to traditional bond investments.
Well, what a difference eight months make:
The U.S. yield curve steepened dramatically over the past several months, driven by expectations for an improving economy, massive fiscal stimulus and a continuation of accommodative monetary policy.
To provide some perspective, the rise in the UST 10-Year yield began early last August when the all-time low watermark of 0.51% registered on August 4. Since that date, the rate increase has been an eye-opening 120 basis points (bps) through March 18.1 However, the development getting the lion’s share of attention is what has transpired so far this year, where the rise has been a whopping 78 bps.
At the same time, U.S. credit spreads have narrowed and come all the way back to reside at pre-pandemic levels. In fact, both investment-grade and high-yield are hovering near lows not seen since 2018.
The result is that, for the first time in a long time, investors can now generate current income out of their bond portfolios that is higher than what they can get from their equity portfolios:
Portfolio Implications
From a portfolio perspective and using the yield information above, let’s begin with a comparison of the current income available from a traditional stock and bond portfolio and the WisdomTree Model Portfolios that are designed explicitly to optimize risk-adjusted current income, specifically the Global Dividend model, the Global Multi-Asset Income model and the Siegel-WisdomTree Longevity model:
Conclusions
Despite the higher current income available from bond allocations, we view the total return risk to be much higher in the bond market. In our base case outlook, we believe rates will continue to grind higher, resulting in a further steepening of the yield curve. Credit spreads could also continue to tighten, but the runway from present levels is a shrinking one.
From a portfolio perspective, we continue to recommend that investors seeking to optimize risk-adjusted current income continue to focus on their equity allocations because, well, “you never can tell.”
Originally published by WisdomTree, 3/24/21
1 Source: Ycharts, as of March 18, 2020.
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