by Brian Rehling, CFA, Head of Global Fixed Income Strategy
- The lack of a blue wave in the recent elections suggests that fiscal spending measures are likely to face a difficult path for approval.
- Without significant new spending measures, we expect rates to remain relatively low as lawmakers once again focus on debt and deficit concerns.
What it may mean for investors
- We recommend investors look for higher yielding opportunities — such as preferred securities and investment-grade and high yield corporate and municipal securities — in what we expect to be a relatively low-yield environment over the coming years.
Debt and deficits have been increasing for years. Both Democratic and Republican administrations have a propensity to deficit spend – after all, it is easier to sell tax cuts and spending priorities to your constituents than fiscal discipline. There tend to be fewer roadblocks when a single party controls both branches of Congress and the presidency.
The lack of a blue wave in last week’s elections will make it more difficult for either party to push through substantial new spending measures. Many investors assume that deficit spending must lead to inflation and higher interest rates. While one day we may see meaningfully higher rates due to deficit spending, we believe that investors will be waiting a very long time for such a reality. For a closer look at the non-partisan facts relating to the debt and deficit, please ask your investment professional for our new report, “Paying America’s bills.”
10-year Treasury constant maturity rate
Implications for investors
Our expectation is that yields across the curve will remain near historically low levels, likely for years. Such an extended low-rate environment should continue to drive investors into more yield-oriented products, in our opinion. We recommend that investors consider acting now to move out of excess cash holdings and acquire yield-oriented investments.
Corporate and high yield bonds — Moving down the credit spectrum is a viable strategy to increase yield but must be done with caution. We believe that investors should emphasize sound credit analysis, with a strong focus on selectivity among issuers and sectors. We recommend that investors consider using active management when purchasing lower-quality investments.
Preferred securities — Investors may also find somewhat higher yields, longer duration, and more equity-like characteristics in preferred securities. While higher-yield expectations in preferred securities may be desirable for many investors, this sector can exhibit unusually high volatility during times of stress. We favor purchasing income in preferred securities with a buy-and-hold mentality.
Emerging market fixed-income — Investors may consider holding emerging market fixed-income securities. The higher yield available in this asset class would be attractive, especially those issues denominated in local currency, as the potential for a weaker dollar increases should markets be concerned with U.S. fiscal trends.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax (AMT). Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. There are special risks associated with investing in preferred securities. Preferred securities are subject to interest rate and credit risks. Interest rate risk is the risk that preferred securities will decline in value because of changes in interest rates. Credit risk is the risk that an issuer will default on payments of interest and principal.
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The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.
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