Equities more likely to develop, however discovering yield stays troublesome
krisanapong detraphiphat | Moment | Getty Images
The 2020 lows were a big contributor to a stock market that had a banner year after the March pandemic hit.
Low interest rates also annoyed investors seeking returns on bond purchases to diversify portfolios and reduce risk. While bond yields are likely to remain meager in 2021, much higher yields are available on alternative fixed income investments that individual investors typically overlook.
Many sectors of the market are poised to resume the growth fueled by the Fed’s rate cut last spring – a move whose effectiveness should not have been surprising given its track record. Conditions pointing to stock growth in 2021 include low interest rates, continuation of the Fed’s bond-buying program at current levels and the expected economic recovery related to coronavirus vaccinations. The introduction of vaccines appears to have been a factor in a partial rotation that showed signs of a start last summer, from some growth technology companies to value stocks, including industrials.
Among those industrials are infrastructure stocks that can benefit if Congress passes an infrastructure bill.
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Infrastructure legislation has been discussed for years, but could actually happen in 2021.
President-elect Joe Biden’s campaign included a $ 2 trillion infrastructure agenda, and some congressmen are now using the “i-word” because the deteriorating condition of the country’s roads and bridges is now critical. According to the American Road & Transportation Builders Association, Americans crossed structurally defective bridges 174 million times a day in 2018 alone – and little has been done to improve them since then.
Even if Congress fails to act, infrastructure inventories are already being boosted by rising spending on private infrastructure – ports, renewables, and communications equipment – which set a North American record of $ 226.5 billion in 2019, up from an all-time high in 2020.
Infrastructure companies are already benefiting. In the seven weeks between November 4 (the day after the election) and December 22, the Indxx US Infrastructure Development Index rose 8.04% – about 1 percentage point more than the S&P 500.
A new freeway under construction in Birmingham, Alabama.
Dan Reynolds Photography | Moment | Getty Images
Today, infrastructure also refers to IT / tech infrastructure, which also includes semiconductors. While growth in big tech stocks has recently flattened, the MVIS US Listed Semiconductor 25 Index rose 20.5% over the same seven-week period. Semiconductor companies, whose merchandise ranges from internet-connected fridges to electric cars, are deployed in data centers to handle the growing internet traffic caused by the 5G data tsunami.
Investors, who are likely to get good stock returns in 2021, will continue to be dismayed by the scarce returns on corporate and government bonds as they attempt to diversify their portfolios with uncorrelated investments to reduce risk.
However, they may be able to solve this problem with alternative forms of bonds and bond-like investments which, while currently advantageous, are likely to be under your radar. These include:
• Taxable municipal bond funds. Due to the Tax Cut and Employment Act of 2017, state and local governments and agencies are refinancing tax-free Muni bonds with taxable bonds – a scratch for some as Muni bonds are synonymous with “tax-free”.
To attract investors, some issuers pay substantial returns, resulting in fund returns of 5% to 6%. For many investors, this translates into an after-tax return of around 3.5%, compared to 2% on many tax-free Muni bonds or the taxable returns of 2% to 3% on high-quality corporate bonds. The interest rate risk of taxable munis is roughly the same as that of tax-free issues.
Some investors may be concerned about the solvency of issuers due to financial problems related to pandemics, but the federal government has a long history of bailing out local governments in dire straits.
• floating rate preference equity funds (also known as floating rate funds). As a kind of bond-stock hybrid, preferred stocks can serve as a viable, higher-paying alternative to bonds, but with less volatility than common stocks. With floating rate preferred stock funds, investors can get some protection against rising interest rates – an effective selling point, as interest rates can only go up. The current dividend yields of the funds range between 4% and 5%.
More recently, some companies have begun offering fixed to floating rate preferred stocks that offer a fixed rate of return for a specific term and then are floating at the applicable interest rates. Some newer issues have fixed rates of up to 4% which are later converted into floating rates tied to the London Interbank Offered Rate or 10 year government bonds. However, a different benchmark can be used for future issues.
As always, the devil is in the details: the length of the fixed term, the range of variability and the behavior of the reference interest rate. Active management is important in all preferred stock investments as managers can avoid the negative return problems inherent in the indices.
• Bank loans or senior loan funds. Investors with a little more risk tolerance might be interested in these fixed income funds that buy commercial loans. While borrowers may have sub-investment grade loans, this risk is offset by the loans’ senior debt status, which means that the fund holdings pay out ahead of other forms of debt and shareholders.
Some of these mutual funds pay more than 6% annually but may have redemption restrictions. Exchange traded funds in this category are less complicated, of course, but they pay less – around 4%. Again, active management helps as managers can avoid bad loans in indices.
Using these unconventional solutions may require some study, but individual investors learning their dynamics can achieve significantly higher returns than traditional fixed income vehicles while still having sufficient levels of comfort.