Frustrated by Low Interest Rates?

The Bond Market has been rallying since February on concerns about a potential Greek default and slowing global economic growth. While this has been good for bond returns, it has been very painful for investors who need cash flow. Bond investors have seen their investment income from bonds shrink over the last decade, and were hoping that a solid economic recovery would provide some much needed relief, in the form of higher interest rates.

Many investors are tempted to reach for higher interest-rate products, as articles and investment professionals have touted ideas, such as “fixed income alternatives.” These alternatives generally have significantly higher risk characteristics than most fixed income investors are willing to take, and can lead to large portfolio losses in the future.

In these frustrating times for fixed income investing, there are several things we are doing, to somewhat mitigate the effects of low interest rates. First and foremost, we are maintaining disciplined laddered bond portfolios. We know that periods of rising interest rates are in our future, but we don’t know when. By investing in maturities ranging from 1-7 years, we take advantage of a steep yield curve, but don’t take undue risk of investing in long maturity bonds. Long bond portfolios will be damaged the most by rising interest rates.

Another strategy that we recommend for fixed income clients, depending on their risk tolerance, is investing a small portion of their portfolio in income oriented stocks. There are select blue chip stocks, paying dividends of 3-4%, which give our clients higher income than short term bonds and the opportunity for growth. Many of these stocks have a history of raising their dividends annually, which amounts to a pay-raise for our clients. This strategy helps offset inflation when we begin to see it on a regular basis. With the 5 year Treasury yield around 1.5%, it also gives clients a much needed boost to their income.

With economic growth slumping a bit, the forecast is calling for lower interest rates to continue through 2011 and possibly through 2012. While that forecast is very frustrating, there are reasonable strategies that fixed income investors can employ to boost their incomes, without taking significant risk.

Summer Stock Sell-off

Several factors have contributed to the sell-off that has seen the Dow Jones Industrial Average shed over 600 points, or nearly 5%, since reaching its 52-week high in early May. US manufacturing and employment growth has been weaker than expected lately. Emerging markets nations, such as China and India, have intentionally slowed their economies to combat rising inflation. Coupling fears of slowing global economic growth, with renewed concerns of a default on Greek sovereign debt, has compelled investors to sell higher risk stocks, and seek the safe haven of bonds once again.

US Corporations have continued to produce strong sales and earnings, but this has not been enough lately, to overcome fears of slowing economic growth. The steep yield curve is certainly not implying that we are headed for a recession at this time, but rather, a slow patch due to the aforementioned headwinds. With conservative estimates of Global economic growth still ranging in the 3-4% range, we are not expecting more than a bull market correction. As such, we will be looking to add to our positions of quality growth stocks throughout this weakness in the markets, as long as our thesis on global growth appears intact.