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Bottom line up top:
- Holiday cheer or new year drear: What will December bring? For consumers, there are 16 shopping days until Christmas, and for investors, just 12 trading days. In either case, the holiday season is in full swing, and like countless children around the world wishing for something special from jolly old Saint Nick, equity markets are hoping the U.S. Federal Reserve will bring them a comfy-cozy interest rate cut (size 25 basis points, please) at next week’s Fed policy meeting. Market odds currently favor just such a move.
But while equity markets are exuding holiday cheer as they trade at or near all-time highs, public fixed income investors appear more reserved, preparing for a higher-for-longer interest rate environment as the bond yield backup that followed the Fed’s first rate reduction in September remains intact. Unexpected economic resilience in the wake of that cut makes it difficult to divine the direction and pace of monetary policy. Last week’s release of consensus-topping U.S. nonfarm payrolls for November offered the latest evidence of labor strength, as job creation rebounded from a weak October marred by disruptive hurricanes and worker strikes. Meanwhile, wage growth remained steady at +4.0% year-over-year.
On balance, we think investors needn’t be overly concerned that the Grinch or Scrooge will derail the Fed’s sled this December. It’s also worth noting that the current level of the real fed funds rate is not an outlier relative to history (Figure 1). So even if a beloved flying woodland creature with a storied illuminative nose were waylaid, this investment season still offers sound portfolio allocation ideas that can counter the potential chill of a higher-for-longer rate environment.
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This investment season still offers sound portfolio allocation ideas that can counter the potential chill of a higher-for-longer rate environment.
A milder and more protracted decline in interest rates means fixed income investments may not benefit much from capital appreciation in the near term.
Portfolio considerations
The U.S. economy is approaching 2025 on solid footing, with GDP growth above expectations and the employment market remaining resilient. We expect the Fed will continue its easing cycle, but at a slower pace than markets previously anticipated. A milder and more protracted decline in interest rates means fixed income investments may not benefit much from capital appreciation in the near term. Against that backdrop, our fixed income positioning for next year is focused on four themes:
- Current yields are near their highest levels in more than 15 years. Higher base rates have significantly enhanced income potential, with yields of about 6% or more for investment grade plus sectors such as preferred securities and securitized assets, including asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) (Figure 2).
- Short- and long-term rates will be higher for longer. That makes exposure to shorter-duration, floating-rate instruments such as senior loans — currently yielding 8.5% — a compelling choice, especially given their sound credit fundamentals. Like senior loans, ABS are also relatively low duration, in addition to providing attractive yields. Also worthy of consideration are esoteric securities backed by nontraditional assets, offering a spread between 75 and 125 basis points in yield compared to short-maturity corporate bonds.
- Balance duration risk with credit risk. Within investment grade categories, we are less positive on corporates, where duration is much longer than in other fixed income sectors. In contrast, preferred securities — in particular, the $25 par segment — offer nearly 1.5% of yield per year of duration. Preferreds also look well-positioned for 2025, as potential deregulation and an expected pickup in M&A (mergers and acquisitions) activity could bode well for banks, the largest issuer of preferreds.
- Position for volatility.In the below-investment grade space, we favor an up-in-quality approach. Within senior loans, we find exposure to BB and B rated issues particularly attractive. BB rated loans, for example, have a healthy interest coverage ratio of 4.X, according to Bloomberg.1
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
- macro and asset class views that gain consensus among our investors
- insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
- guidance on how to turn our insights into action via regular commentary and communications
Related articles
Access previous issues of Saira Malik’s weekly CIO commentary on strategy and portfolio construction.
U.S. Treasury yields increased across the curve, weighing on returns, but spread sectors broadly outperformed.
The Fed cuts, but signals a new stage of slower easing.
Endnotes
¹ The interest coverage ratio measures a company’s ability to pay interest on its outstanding debt. It is calculated by dividing the company’s earnings before interest, taxes, depreciation and amortization (EBITDA) by the company’s interest expense.
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance does not predict or guarantee future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. Please note, it is not possible to invest directly in an index.
Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. A focus on dividend-paying securities presents the risks of greater exposure to certain economic sectors. Dividend yield is one component of performance and should not be the only consideration for investment.
Equity investments are subject to market risk, active management risk, and growth stock risk; dividends are not guaranteed. Non-U.S. investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. The use of derivatives involves additional risk and transaction costs. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Credit risk refers to an issuer’s ability to make interest payments when due. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Non-U.S. investments involve risks such as currency f luctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
Investing in preferred securities entails certain risks, including preferred security risk, interest rate risk, income risk, credit risk, non-U.S. securities risk and concentration/ nondiversification risk, among others. There are special risks associated with investing in preferred securities, including generally an absence of voting rights with respect to the issuing company unless certain events occur. Also in certain circumstances, an issuer of preferred securities may redeem the securities prior to a specified date. As with call provisions, a redemption by the issuer may negatively impact the return of the security held by an account. In addition, preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure and therefore will be subject to greater credit risk than those debt instruments. Credit risk is the risk that an issuer of a security will be unable to make dividend, interest and principal payments when due. Interest rate risk is the risk that interest rates will rise, causing fixed income securities prices to fall. Income risk is the risk that the income will decline because of falling market interest rates. This can result when an account invests the proceeds from new share sales, or from matured or called fixed income securities, at market interest rates that are below the account’s current earnings rate. An investment in foreign securities entails risks such as adverse economic, political, currency, social or regulatory developments in a country including government seizure of assets, lack of liquidity and differing legal or accounting standards (non-U.S. securities risk). Preferred security investments are generally invested in a high percentage of the securities of companies principally engaged in the financial services sector, which makes these investments more susceptible to adverse economic or regulatory occurrences affecting that sector concentration/nondiversification risk). It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
Nuveen, LLC provides investment services through its investment specialists.
This information does not constitute investment research as defined under MiFID.
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