Back on Stable Ground? The Bond Market and Fed Intervention - Adviser Investments

Back on Stable Ground? The Bond Market and Fed Intervention

April 8, 2020

Episode Description
Featuring Jeff DeMaso and Chris Keith

Last month’s stock market rollercoaster got most of the headline ink, but March was also a pretty wild month for the bond market. We saw record-low yields—even negative yields—and the differences in yields between Treasurys and other types of bonds reached their highest point since the 2007–2008 credit crisis.

What are bond investors to make of the Federal Reserve cutting rates to zero and launching a series of market-friendly programs? In this edition of The Adviser You Can Talk To Podcast, Director of Research Jeff DeMaso and Senior Vice President, Fixed Income Chris Keith joined up for a timely discussion about March’s bond market dislocation and bonds’ role in portfolios.

Topics covered include:

  • How the Fed’s actions impact bond investments
  • What prompted widespread selling of municipal bonds
  • Where bond traders are seeing opportunity
  • Do bonds now look better over the long run than stocks?

It can be jarring to see dramatic moves in what’s considered a conservative asset class like bonds. But cooler heads have prevailed and we still strongly believe that high-quality bonds remain an essential element of many portfolios. Click above to listen.

Missed our update last week? Click here to listen to the full podcast or read a transcript of Chairman Dan Wiener and Chief Investment Officer Jim Lowell’s “Parsing the ‘New Bull Market’ as the Pandemic Worsens.” To learn more about all that we here at Adviser Investments are doing to respond to the crisis, including a video message from CEO Dan Silver, click here for our full coverage.

Episode Transcript

Jeff DeMaso:
The past few weeks may not have been completely smooth in the bond market, but the rockiest period lasted a relatively short amount of time and big part of the reason why was the Fed acting as the buyer of last resort and restoring calm to some of the worst market fears. Listen in as [Senior Vice President, Fixed Income) Chris Keith, aka “The Bond Guy,” and I dig in to the bond market.

Jeff DeMaso:
Hello, this is Jeff DeMaso and I’m the director of research here at Adviser Investments. We’re here with another The Adviser You Can Talk To Podcast. Today, I’m joined by Chris Keith, the bond portfolio manager at Adviser Investments.

The stock market gets all the headlines, but recently, the bond market has made headlines of its own. And March was a pretty wild month in the bond market. We saw record low yields, negative yields even, credit spreads widened out to levels not seen since the credit crisis. The Fed cut rates to zero and revived a lot of old market friendly programs. So today, I wanted to bring Chris Keith, who we affectionately call “The Bond Guy” around the office, and quiz him on the bond market. Chris, thanks for joining me today.

Chris Keith:
Hey there, Jeff. It’s good to be with you today. Of course, from a safe social distance.

Jeff DeMaso:
Of course. Well, we’re working remotely as just about everybody else is. It’s alright. Let’s turn to the markets. Bonds are typically seen as the “safe part” of someone’s portfolio. But to be honest, it didn’t quite feel all that safe in the bond market in March. Chris, let me ask you a technical question. What the heck happened in the bond market?

Chris Keith:
That’s a fair question about what the heck happened in the bond market and what I think it was, was a classic overreaction as investors responded to the unknown about how deep and how severe the fallout from the coronavirus is going to be on the economy. But I think we have to put this into perspective. It was a bad, very bad couple of days, if you will, for the bond market. But just as quickly as things went down, the recovery began in short order thereafter, and large parts of the bond market have actually recovered quite nicely back to even the levels that we had seen prior to the sell-off.

Chris Keith:
So I think it’s not entirely something that investors should be completely panic-stricken over. I think they should be aware of it, but I think we have to put this into perspective because many parts of the bond market are still showing positive returns on a year-to-date basis. And as far as the ones that aren’t showing positive returns, they’re not as bad as they were a couple of weeks ago and that’s because cooler heads have prevailed.

Jeff DeMaso:
No, Chris. I think that’s great to try and reign me in a bit there. Still, I want to talk a little bit about this few days where there did seem to be some panic selling. It was kind of the classic flight to safety as the market talks about where investors just go to Treasury bonds, it’s all they want, it’s Treasury bonds and everything else. What was going on there? Why were prices falling? Can you dig into some of the psychology and what was going on in the market?

Chris Keith:
Sure. So it was a textbook example of the flight to safety, which means you sell everything and go to the safety and security of Treasury bonds. And I think the reason for that is because investors are just unsure about how deep the impact of the economic slowdown or shutdown is going to be. They just don’t know who is going to be challenged the most when it comes to meeting their debt service obligations, which means, are you, the issuer, going to be able to pay me my principal and interest when due?

And investors would rather shoot first and ask questions later, and that’s why they sold everything they had. Whether you were a triple-A rated company like Microsoft, or a more challenged company such as Carnival Cruise, which demonstrated that it did have access to the capital markets, although it had to pay a fair price to get there.

Jeff DeMaso:
Yeah. I think let’s come back to Carnival and some of the new issue market in just a sec. But I just want to emphasize something you said there about investors, even buyers not coming into the market. One way I like to think about the bond market is a bit like a yard sale.

So, if you need to raise money, you might gather up some of your old items in your house and bring them out to your yard. Or in Brooklyn, we call them stoop sales. And try and sell them to buyers walking by. And in normal times, it’s relatively easy. You’re trying to sell some stuff and people are happy to buy them. In times of stress, which is what we saw for a while in the market here, was the buyers just didn’t show up.

Jeff DeMaso:
Or if they did show up, they were offering pennies on the dollar to what you thought things were worth. Or they would ask you for not the things that you had outside, but maybe that TV they see in the window. You can think of that as a Treasury bond looking for your good items. And the Fed stepped in and helped to quickly right the ship and give buyers confidence to be in the market and pay a fair price, acting as that buyer of last resort. So, can you talk a bit about the Fed, Chair Jerome Powell, and what they were doing in March?

Chris Keith:
The Fed, working in collaboration with the Treasury Department, either dusted off some of their old programs or created new ones to help restore a sense of calm and ease into the marketplace and make sure that it absolutely functions at some level. It may not function completely smoothly, but at least it began to function.

And the Fed gave investors that sense of comfort that they needed to see, knowing that at least there will be programs out there to help some of these corporate issuers, to help some of the bond market participants that might want to sell positions, to raise capital for whatever reason they need or to meet redemption.

Chris Keith:
So the Fed stepped in and fulfilled a very important role by bringing order back to the market. And as far as investors looking to buy items that may not be on the front lawn of your yard sale, at least they’re out there looking to buy something. And as I’ve said in the past, liquidity often means not only the ability to sell at a fair price, but the ability to sell at any price. And maybe they’re being choosy about what it is that they want to buy. But at least they’re out there buying a few items and the bond market doesn’t get back to normal until some of the higher-quality items have proven that they have access to the markets.

Jeff DeMaso:
Yeah. I mean, the Fed really learned some lessons, I think, from 2008, 2009. They acted very quickly cutting rates even before their regularly scheduled meeting. And I think that’s an important point. You made it earlier as well, it was a short time-period where there was stress in the market. And we’ve seen the market start to recover and heal. We’ve seen bonds rally, Total Bond Market Index, Vanguard’s fund, is up 3.5%  percent this year, which is a fair sight better than the stock market down 20%. You mentioned Carnival Cruise and the ability of companies to issue bonds and raise money during these difficult times. What’s that looking like, I guess, both for companies like Carnival, but maybe in the muni market as well?

Chris Keith:
Sure. Well, some good observations there. And yes, Carnival, one of the most challenged companies of all, I mean, they were in all the negative headlines for a while there.

Jeff DeMaso:
I don’t want to be on a cruise anytime soon.

Chris Keith:
I don’t blame you. I wouldn’t either. But I mean, here’s a company that is really in the eye of the storm here as far as who’s going to be most negatively impacted. And they are, to a degree, fighting for their survival and they needed access to capital.

They floated the idea that they wanted to come to the market. And originally, they were talking about issuing $3 billion of bonds with rate of 12.5%. And that got enough attention of investors to say, “Wait a minute, that looks attractive and maybe I’m willing to take that level of risk. I might not put all my eggs in that basket, but I’m willing to put some of them in that basket.”

Chris Keith:
And lo and behold, by the end of the day, after they had talked about coming with $3 billion, they were actually able to sell $4 billion in new debt, which means raising an additional billion dollars in capital, much needed capital to help keep the company afloat, no pun intended. And knowing that, Jeff, but they were able to do it at a lower rate. So instead of offering bonds to yield 12.5%, they ended up with the coupon of 11.5%. And again, it proves that the market is functioning. It may not be completely smooth, but the fact that a company like Carnival can get in there and sell bonds under this extreme difficult time is a good indication. And it’s not just Carnival, by the way.

Chris Keith:
There are plenty of other companies that have been able to tap, we call it the credit markets or the new issue market, the corporate bond market. So if Carnival represents the far extreme on the negative side or on the lower-quality side, then you’re looking at companies like ExxonMobil, FedEx, Visa. They were all able to raise a significant amount of capital money by selling bonds to investors that had been ready, willing and able to step up and buy and invest at these new higher levels, and they’re happy to do so.

Jeff DeMaso:
Yeah. I think that’s a good point, that the market is still functioning and if some companies do have to pay a higher price for it to keep working for them. Let me push you a bit on the muni market (municipal bond market), tax-exempt bonds where investors can get income that’s sheltered from the tax man. What are we seeing in that part of the market?

Chris Keith:
To begin with, muni is such a different asset class and that’s a couple of reasons for that. One, it’s a smaller market by size, but also a good portion of that market is dominated by individual investors. And when these investors decide to sell their holdings in large numbers, it forces managers to sell bonds to be redemption. So the muni market didn’t escape the volatility that we saw in the corporate bond market. In some cases, that actually was more pronounced. And again, I think that’s because of the nature of the biggest slice of the market being the smaller individual type of investors. But even at that, it only lasted a couple of days, if you will. And the muni market has rebounded greatly.

Chris Keith:
And I won’t say that the panic selling that we saw led to panic buying, but I will say that more seasoned investors, investors like us for example, we saw how ridiculously cheap some of the bond prices, and some bond prices got, that we thought that it was worthwhile to step in and begin buying. So if you have confidence in who the underlying issuer is, and we have a little bit of insight into what’s going on in the marketplace, then yes, we are ready, willing and able to step in and to pick up some of those bonds at those better prices. I think that the selling in the muni market was perhaps more over done than some of the selling in the corporate bond market.

Chris Keith:
It’s still not completely back to normal, if we look at some of the ratios relative to other major asset classes. But muni still represent a very low risk, high quality investment and you get that tax-exempt kicker to boot. So, I think it’s an important part of the market and it’s absolutely necessary because cities and states and towns all across the country are always going to have a demand for new capital.

For us, I think it’s a question of making sure that we’re investing in the type of issuers that we really feel comfortable with, whether it’s the general obligation debt that’s supported by income taxes, or sales taxes, or ad valorem property taxes, or essential purpose utilities that are more dependable with their revenue streams. I think the muni market still offers a pretty good safe haven in here for investors.

Jeff DeMaso:
Because you can clearly go deep on the muni market, but if I can… Some of what I think I’m hearing from you is that there’s some opportunity if you want to be picky and choosy about what you’re buying. And it sounds like that applies to the corporate market as well. In times of stress, just like we talk about the stock market, same applies to the bond market.

Chris Keith:
Jeff, you’re absolutely right. There’s a ton of opportunity out there. And when I see some AAA issuers, state general obligations trading at a multiple, many multiples of what the Treasury bond is trading at, I feel completely comfortable and confident investing in them because some of the names that were picked up, again, AAA-rated states that just quite frankly, they’re not going to go out of business. They’re not going to go away. There’s still going to be here tomorrow when all the dust settles. And I think that these are great opportunities and they’re opportunities that we are taking advantage of.

Jeff DeMaso:
All right, Chris, you’re The Bond Guy. So you might be a little bit biased on this one. But let me put you on the spot here. As I’m starting to see articles saying that bonds are better in the long run than stocks. Agree or disagree?

Chris Keith:
Well, I certainly love the bond market. But even I, as a dedicated lifelong bond guy, recognized that an investor portfolio includes a lot more pieces than fixed income. So I guess I’d have to disagree, but I do want to say that bonds absolutely continue to prove time and again that they deserve some representative value in investor portfolios.

Jeff DeMaso:
Okay. So, you’re going in with the neither, both are for the long run.

Chris Keith:
Yes.

Jeff DeMaso:
Fair enough. All right, Chris. I appreciate you joining me today. Any final comments while I’ve got you?

Chris Keith:
Yeah, I would like to simply say that high-quality bonds are there when you need them most. And I don’t mean just from a standpoint of being able to sell a position to raise cash for an emergency need, but I also mean as a cornerstone of your portfolio that you worry a lot less about during times of stress such as what we have right now.

Jeff DeMaso:
Great. Thank you, Chris.

Chris Keith:
Jeff, thank you very much.

Jeff DeMaso:
This has been Jeff DeMaso and Chris Keith from Adviser Investments thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback really is always welcome. If you have any questions or topics that you’d like us to explore, please email us at infoatadviserinvestments.com. Thanks as always for listening.

Podcast released on April 8, 2020. This podcast is for informational purposes only. It is not intended as financial, legal, tax or insurance advice even though these topics may be discussed. Information and events addressed in this podcast, as well as the job titles, job functions and employment of the podcast’s participants with respect to Adviser Investments, LLC may have changed since this podcast was released. For more information on each individual featured in this podcast, see the Our People section of our website.

The Adviser You Can Talk To Podcast is a trademark of Adviser Investments, LLC.

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I think we have to put [bond market turmoil] into perspective, because many parts of the bond market are still showing positive returns on a year-to-date basis.


Chris Keith

Senior Vice President, Fixed Income Manager

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