2023 Bond Strategy.
Bonds are losing money. Countries face heightened exposure to corporate defaults. Sri Lanka and Pakistan are already seeking IMF bailouts. Risks include: Interest rate risk. Credit risk. Duration risk. Opportunity Costs.
How can fixed income investors protect themselves? Includes a 5-Part 2023 Bond Strategy.
Rising interest rates create opportunities for savers and fixed-income investors to finally earn a yield. However, there’s an overhang of legacy debt that resulted in U.S. long-term government bonds losing more than the S&P500 last year, at -26.08% and -19.44% respectively. Corporate bonds posted a miserable performance of -15.76%.
This makes investing in bonds and other fixed income assets very tricky. If you were in bonds or bond funds prior to 2022, it’s time to do a forensic audit of your holdings to weed out the losers. Particularly as we’re seeing signs of potential corporate debt distress. (We’ve been warning to steer clear of bonds since 2012. Investors weren’t being paid to take on the risk, plus bonds have been illiquid and negative-yielding for years now.)
The IMF warned yesterday that the rapid rise in worldwide corporate debt, combined with the soaring costs of borrowing money, has made countries vulnerable. According to the IMF, the risks of corporate defaults spilling over into the banking sector and creating financial instability is heightened in 2023 – to levels almost as concerning as we saw during the pandemic, when most banks suspended their corporate buybacks and some stopped paying dividends.
In the blog entitled “Countries Should Act Now to Limit Rising Risks from Corporate Distress,” IMF researchers used AI to predict that “This build-up of risk in the corporate sector and a doubling of funding costs for even the safest issuers could pose serious problems for many economies and their financial systems.” Thirty-eight of the economies tracked by the IMF are at medium risk, and seven economies, mostly from Europe and Asia, are at high risk of systemic corporate distress. The high-risk countries are not all small developing world countries like Sri Lanka and Pakistan. Collectively they account for 21% of worldwide GDP.
Unlike the pandemic, we won’t be printing up another $12 trillion to rescue everything. Instead, countries are being encouraged to find a way for failing companies to restructure, to decide which firms and industries need to be rescued, to “improve transparency of lenders’ assets and liabilities, refrain from further lending to firms that cannot pay existing debts, strengthen capital buffers, and conduct comprehensive stress tests.”
Which countries are the most vulnerable?
According to the IMF (in a February 2022 white paper), the developed world countries that are the most vulnerable to corporate debt are: Portugal, Norway, Greece, Spain, Iceland, New Zealand, Austria, Italy and the United States. The developing world countries with the most vulnerability are: Argentina, Vietnam, India, Kuwait, Pakistan, Oman, Sri Lanka, Nigeria, Tunisia, Indonesia, South Africa and Chile. (We took Chile off our Hot Country List in June of 2022. Click to access that blog.)
After the IMF report, in summer of last year, Sri Lanka defaulted on its debt and has been in negotiations for a bailout since. Creditors have been asked (forced) to take a write-down. Pakistan asked the IMF for a bailout yesterday.
The U.K. Gilt Crisis
Great Britain was listed as having moderate risk to corporate debt. However, there was a Gilt Crisis in September of 2022. 10-year Gilt yields soared from 1% to 4%. The pound plunged below the U.S. dollar (for the first time in history).
Things were quickly resolved by the Bank of England, and by giving Prime Minister Truss the boot. However, it is a reminder that crises can flare up without warning, even with large countries that are supposed to be better prepared for them. For this reason, it’s a good idea to diversify our “safe” holdings, and to understand the underlying credit risk and rating of any bank, corporation or country we are doing business with. (Again, we took Chile off our Hot Country List in June of 2022. Click to access that blog.)
Additional Risks in the 2023 Bond Market
Inflation has forced central banks to tighten up the money supply and slow down the economy in order to prevent sky-high prices from becoming entrenched. In 2022, the U.S. Fed Funds rate went from 0% to 4.5% in just one year. The FOMC is expected to raise rates by another 25 basis points today (Feb. 1, 2023), with a total rise of 50 basis points in 2023. While there are some signs of inflation abating, few are expecting any interest rate cuts in the U.S. this year. Companies will not be able to live on borrowed time and money to make ends meet in 2023.
Inverted yield curve
As you can see in the attached chart below, inverted yield curves are 100% correlated with recessions over the past half century. The gray lines are the recessions. Recessions tend to make everything more challenging.
Money Market Funds
When corporate distress spills over into the banking industry (the lenders), it can become a crisis, such as happened in the Global Financial Crisis of 2008. During the Great Recession, banks were bailed out by the taxpayers to prevent a catastrophic economic disaster. This time around, banks and financial services companies are protecting their liquidity through redemption gates and liquidity fees in their money market funds. However, will that be adequate if corporate defaults start to pick up? Also, money market funds can lose value (as any fund can).
So, is this where you want your safe money to reside? (Better double-check your retirement and brokerage accounts.) By the time redemption gates, liquidity fees and breaking the buck make headlines, the tools might already be in use. While we’re all hoping for the elusive “soft landing,” this is not guaranteed, which is why the IMF is encouraging countries to do even more to protect their banks. You can get more information on FDIC, SPIC, Money Market Funds and More in my blog (click to access).
Over half of the S&P 500 is at or near junk-bond status. Ford is classified as a junk bond. Many corporations borrow money from investors for a very long term, sometimes even longer than we’ll live. Because interest rates jumped so high in 2022, those long-term holdings that are paying less than short-term Treasury bills lost a great deal of value.
There is a lot more credit risk in long-term bonds than most fixed income investors are aware of. It’s important to know the credit rating, the revenue growth or decline rate, the debt-to-equity ratio, and the prognosis of how the company, state or country can fare in a recession, before committing to lending our money. If the entity already has our money, it might be worth it to consider selling out of the position, while there is still enough liquidity to do so. Each holding will have a different risk/reward rating and should be examined separately. (I offer an unbiased 2nd opinion. If you’re interested, email info@NataliePace.com for pricing and information.)
Interest Rate Risk
There is an inverse relationship between interest rates and bond values. When interest rates rise, the value of the bond goes down. The faster the rise, the more severe the plunge. That is why we saw such losses in long-term debt last year and why the U.K. had a gilt crisis.
Interest rates are predicted to rise again in 2023, albeit at a slower pace. So, interest rate risk remains a headwind for bonds in 2023, particularly for the most vulnerable corporations, with the slowest revenue growth and the highest debt load.
Mid-term and long-term bonds carry heightened risk in a Debt World, particularly as the world braces for a potential recession in 2023. It’s important to keep the terms short and the creditworthiness high.
Here is a chart that indicates all of the debt levels in the United States, where the total debt and loans exceeds $92 trillion. As you can see, debt is extremely elevated in every corner.
2023 Bond Strategy
So what is a good strategy for bonds in 2023?
1. Keep the Terms Short
2. Keep the Creditworthiness High
3. Ladder Maturities
4. Consider Safe, Income-Producing Hard Assets That You Purchase for a Good Price
5. Diversify. Don’t Put All of Your Money in Any One Bank, Corporation or Country
The devil is in the details. What’s safe (including your bond strategy) is examined extensively on day three of our Investor Empowerment retreats. There are many opportunities that are outside the mainstream where we can get a great return on investment, without taking on much risk. The next online retreat is April 22-24, 2023. If you register by Feb. 8, 2023, you receive the lowest price.
These strategies were also covered in our Bond Master Class (held last Saturday). If you would like access to the recording, email firstname.lastname@example.org for pricing and information.
The “safe” side of our investment strategy is not supposed to lose money. Long-term government bonds lost more value than the S&P 500 in 2022. Corporate bonds lost a lot, too, and are putting some countries at risk of financial instability. So if we’re trusting that someone else is protecting our wealth, without knowing the details of what we own and why, chances are very high that we lost money in 2022 and remain at risk of further capital loss in 2023.
Any broker/salesman who promises us a 7-10% annualized return on our money is not being forthright with us about the risk of capital loss (or the losses incurred in 2022). In a recession or bear market, it’s important to limit our losses. (Almost every investment lost money in 2022. 2023 isn’t predicted to be any better.) In a Debt World, we must adhere to Will Roger’s advice. He once said, “I’m more concerned with the return of my money than the return on my money.” (Keep the terms short and the creditworthiness high.)
Again, I offer an unbiased second opinion on your wealth plan and bond strategy. It’s unbiased because I did not sell financial products. My only incentive is to provide you with the information you need to be the boss of your money. If you are interested in an unbiased, second opinion, email email@example.com for pricing and information.
Email info @ NataliePace.com or call 310-430-2397 if you are interested in learning time-proven investing, budgeting, debt reduction, college prep and home buying solutions that will transform your life at our next Financial Freedom Retreat.
Natalie Wynne Pace is an Advocate for Sustainability, Financial Literacy & Women's Empowerment. Natalie is the bestselling author of The Power of 8 Billion: It's Up to Us and is the co-creator of the Earth Gratitude Project. She has been ranked as a No. 1 stock picker, above over 835 A-list pundits, by an independent tracking agency (TipsTraders). Her book The ABCs of Money remained at or near the #1 Investing Basics e-book on Amazon for over 3 years (in its vertical), with over 120,000 downloads and a mean 5-star ranking. The 5th edition of The ABCs of Money was released on September 17, 2021.
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Natalie Pace is the co-creator of the Earth Gratitude Project and the author of The Power of 8 Billion: It's Up to Us, The ABCs of Money, The ABCs of Money for College, The Gratitude Game and Put Your Money Where Your Heart Is. She is a repeat guest & speaker on national news shows and stages. She has been ranked the No. 1 stock picker, above over 830 A-list pundits, by an independent tracking agency, and has been saving homes and nest eggs since 1999.