Concerns that the spread of the coronavirus may negatively affect economic growth have pulled prices of riskier fixed income investments lower.
We still see room for credit spreads to rise a little higher, meaning additional price declines are possible.
For long-term investors, the entry points for some of these investments are getting more attractive, but we’d caution that it could get worse before it gets better.
The threat of the coronavirus has created a sharp divergence in the bond market. Treasury yields have fallen to new all-time lows, pushing their prices higher. Meanwhile, the prices of more aggressive bond investments—such as high-yield bonds—are down sharply, resulting in higher relative yields.
The higher relative yields may present an opportunity for long-term investors to take some additional risk in their bond portfolios down the road. However, despite the lower prices—and higher relative yields—we caution that there’s room for prices to fall further in the near term.
A rough couple of weeks
Risky fixed income investments have seen their prices decline over the past few weeks. From January 17, 2020 (around the time the coronavirus began making headlines) through February 28, 2020, aggressive fixed income investments have significantly underperformed their higher-quality counterparts like U.S. Treasuries and investment-grade corporate bonds.
Riskier fixed income investments posted losses in the six weeks through the end of February
Source: Bloomberg. Total returns from 1/17/2020 through 2/28/2020. Indexes represented are the Bloomberg Barclays U.S. Treasury Bond Index, Bloomberg Barclays U.S. Corporate Bond Index, Bloomberg Barclays U.S. Corporate High-Yield Bond Index, Bloomberg Barclays U.S. Floating-Rate Notes Index, ICE BofAML Fixed Rate Preferred Securities Index, and the S&P/LSTA Leveraged Loan 100 Total Return Index. Total returns assume reinvestment of interest and capital gains. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no indication of future results.
This can serve as a good reminder that not all bonds are created equal, and that during periods of market volatility or stock market declines, risky investments can suffer large price declines.
When building a balanced portfolio, simply holding “bonds” might not provide the diversification benefits you’re looking for. Riskier investments like high-yield bonds, bank loans, and preferred securities tend to have positive correlations with the stock market, while high quality investments like U.S. Treasuries tend to have negative correlations with stocks.1 If stock prices are declining, it’s good to have investments that might move in the opposite direction to help serve as a buffer and offset some of the stock declines.
Below we’ll go over three parts of the fixed income market that have been hit hard since the threat of the coronavirus surfaced, and we’ll discuss what investors should know about each investment.