“It makes no sense buying good corporate credits at current yields.” —Dan Fuss.
Victor J. Blue/Bloomberg
The putative “bond kings” have reigned only during the bull markets of the past four decades or so, periods in which yields steadily declined, which meant that bonds’ prices moved higher, if not every month, persistently over time.
But 88-year-old Dan Fuss recalls a time when the trend definitely didn’t favor fixed-income investors. “I go back to ’58,” the vice chairman of Loomis Sayles said in a phone conversation this past week. And while he stepped away from day-to-day portfolio management last year, he’s still providing advice and counsel to the Loomis staff.
Fuss arrived about one-third of the way through the post-World War II bear market, which saw long-term government yields rising from 2½%, where the Federal Reserve had pegged them to help finance the war effort, to a peak of 15% by September 1981. A constant-maturity, 2.5% 30-year bond would have lost 83% of its value over that span, according to the classic A History of Interest Rates, by Sidney Homer and Richard Sylla.
But to make investment decisions now, he says, he wouldn’t rely on the history of the 1970s and 1980s, when inflation and interest rates soared to records well into double digits. Back then, clipping big interest coupons and reinvesting them at ever-rising rates helped to offset the bear market’s ravages. Even during the doleful decade of the ’70s, $726 invested in Baa-rated corporate bonds would have grown to $1,153, according to data from the NYU Stern School of Business. (The series started with $100 invested in different asset classes, starting in 1928.)
Now, with paltry yields of about 1.75% on 10-year Treasuries and with triple-B corporates providing only about a percentage point more, there’s precious little interest income to cushion price declines. “It makes no sense buying good corporate credits at current yields,” Fuss declares, arguing that strongly profitable companies with solid balance sheets are acting in the interest of equity investors, not their creditors.
For instance, he continues, some prominent pharmaceutical makers have a history of raising their dividends 5% to 10% a year. Even assuming that their stocks don’t go up over the long term, those growing payouts would mean an equity investor likely would earn at least twice as much, and perhaps four times as much, as the owner of the company’s bonds.
Instead, Fuss would opt for a package of BB credits, the highest rung of what’s still called high yield and with the potential of being promoted to investment-grade. He cites the debt of Ford Motor (ticker: F) and its credit subsidiary as examples. While the auto maker’s bonds remain rated below investment-grade, its shares have more than doubled in the past year, bolstered both by the potential of its electric F-150 Lightning pickup and its strengthening balance sheet. Other speculative-grade credits have taken advantage of salubrious market conditions to refinance high-cost debt and extend maturities, he adds.
But rather than being bought based on careful research and strict selectivity, most bonds these days are traded in blocks of 30 to 40 credits for exchange-traded funds linked to an index. Or they may be acquired by active managers who must hew to some benchmark that they can’t chance falling too far behind. Ideally, those managers would do better if they had stable assets and the flexibility to stray from their benchmark, luxuries not afforded open-end funds, such as Loomis Sayles Bond (LSBRX), which Fuss helmed until last year.
The current, still historically low yields reflect the massive liquidity provided by the Fed and other central banks. “This is not comparable to any previous market I’ve even read about,” Fuss observes.
He likens the market to a frozen pond in March. When the ice gets smoother and slicker, it’s in danger of melting, and it’s time to get back on solid ground. Extending the metaphor, he worries about a catastrophic event, comparable to a big chunk of a glacier breaking off, which was what happened during the markets’ pandemic-induced crisis in March 2020.
Read more Up and Down Wall Street: Rate Jitters Sink Stocks, Bonds as 2022 Dawns. What’s Different This Time.
The markets already seem to fear that the ice will be thinner by the time the weather warms this year. They shuddered this past week at the prospect of the Fed lifting rates and reducing its balance sheet sooner than the consensus apparently had expected—even though the central bank still is pegging its key rate near zero and continues to expand its bond holdings.
Investors might look nostalgically back at the 1950s and 1960s as placid times for the markets, but Fuss says there were plenty of rocky patches in those days. Looking ahead, there are the longer-run risks of climate change, geopolitical disruptions, and the dollar’s loss of purchasing power. The reigns of the erstwhile bond kings already are looking like the good old days.
Write to Randall W. Forsyth at [email protected]
