Divided Highway Ahead?
Published November 19, 2020
Head of Investment and Fixed Income Strategy
Here we are two weeks out from Election Day, and at this point anyway, it looks as if the U.S. government could be a divided highway. Based on the results as of this writing, come late-January 2021, the money and bond markets could be looking at a President Biden, a Republican Senate majority and a Democrat House of Representatives.
A divided government as outlined above would seemingly mean there shouldn’t be any dramatic shifts in the current fiscal policy setting. Sure, executive orders and attendant regulatory action could occur, but meaningful legislation on taxes and spending would more than likely not transpire in such an arrangement. Arguably, an additional pandemic-related fiscal stimulus package could get passed on a bi-partisan basis. However, as I recently blogged, the Fed would continue to be a key force on the bond market landscape, and as a result, it’s ‘pedal to the metal’.
In our opinion, 10-year Treasury yields could move higher in this scenario, but still remain low from a historical perspective. So, how does a bond investor get income without incurring too much risk?
Rather than attempting to enhance yield by extending duration, our preferred approach would be through credit within the high-yield (HY) space. But not just a blanket market cap-based approach to HY. Rather investors should consider a strategy that offers a quality cut for HY by including only public issuers and excluding those with negative cash flow. The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) has both these important investment attributes.
Typically, HY is viewed as having a relatively tight correlation to equities. However, WFHY has shown that its downside, compared to the broader stock market in the two most recent notable risk-off episodes, was visibly lower. Although different time frames may produce different results, consider these two periods under review:
- 2/19/20–3/23/20: S&P 500 was down -33.8% vs. WFHY at -20.5% at NAV; only a 60% correlation
- 9/20/18–12/24/18: S&P 500 was down -19.4% vs. WFHY at -4.5% at NAV; only a 23% correlation
Conclusion
Given the current and prospective interest rate setting for the year ahead, bond investors will once again be confronted with a challenging setting for finding income. With rates at historical lows, the typical equity hedge that longer-term Treasuries offered may not be applicable from an asset allocation standpoint. Against this backdrop, a solution such as WFHY may offer investors the opportunity to enhance income while taking a quality screen into consideration as well.
Unless otherwise stated, data source is Bloomberg as of 11/13/20.
Important Risks Related to this Article
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There are risks associated with investing, including the possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
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About the contributor
Head of Investment and Fixed Income Strategy
Kevin serves as the Head of Investment and Fixed Income Strategy. In this role, he writes macro and fixed income-related content and works closely with the sales, research and marketing teams. In addition, Kevin conducts client-facing webinars and meetings, providing expertise on WisdomTree’s existing and future bond ETFs. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was Managing Director and Chief Fixed Income Strategist for Wealth Management. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S. in Finance from Fairfield University.