MW Three ways to play the bond market as the Fed lowers interest rates, this analyst says

By Jamie Chisholm

It's been a choppy time for stock markets of late as surging Treasury yields rattled investors.

Still, the S&P 500 index SPX sits just 0.9% below its record hit a week ago, with equities supported in part by an understanding that the Federal Reserve has now embarked on a monetary easing cycle.

"Don't Fight the Fed" is a maxim drilled into traders. And currently it means the central bank has stock investors' backs.

But what about those looking to invest for the fixed-income portion of a portfolio?

Matthew J Bartolini, head of SPDR Americas research at State Street Global Advisors, suggests three areas of interest as the Fed reduces short-term borrowing costs and decent economic growth allows yield curves to steepen.

Those worried that credit spreads - the difference in yield between supposed risk-free Treasurys and corporate debt - remain very tight by historic standards, and therefore vulnerable to a widening, should consider a number of factors that underpin the case for credit, says Bartolini.

The U.S. economy is growing, with a healthy labor market and resilient household demand. Corporate profits are poised to deliver a fifth consecutive quarter of growth. Credit upgrades are outpacing downgrades so far in 2024 and a global high-yield default rate of 1.90% is well below the long-term average of 3.75%. Finally, high-yield issuers continue to see strong demand.

So, given this supportive environment, where should investors put money to work as the Fed's rate cuts reduce what's on offer from the $6.3 trillion held in money-market funds.

First, is what Bartolini calls short-term active core strategies. "An actively managed short-duration strategy may be able to enhance income and total return potential, given that the wider opportunity set can include securitized credits," he says. "A yield for a portfolio of 1-3 year U.S. Treasurys can be enhanced by adding under 3-year duration investment-grade credit, high yield credit, and MBS while still retaining a low rate risk profile."

A fund to reflect such a trade is the SPDR DoubleLine Short Duration Total Return Tactical ETF STOT.

Next, are high income strategies, such as exposure to high-yield bonds, senior loans, and preferred securities. "Those three bond sectors still offer yields north of 5.5%, and that healthy coupon may lead to enhanced demand - a potential benefit from a total return perspective that helps justify the tight credit spread environment. And the preferred securities market is still primarily rated investment-grade," says Bartolini.

Funds for this trade include SPDR Blackstone High Income ETF HYBL, SPDR Blackstone Senior Loan ETF SRLN, and SPDR ICE Preferred Securities ETF PSK.

And finally, mortgages and mortgage-biased core active strategies. "With the anticipation of lower central bank rates, and lower rates in general, 30-year fixed mortgage rates have declined and are trading around two-year lows," says Bartolini.

"Analysts project that mortgage rates falling below 6% could spur a refinancing wave. And that could help bring duration in, leading to duration induced price appreciation given how anomalously extended duration is right now," he adds.

Funds for this investment strategy include SPFR Portfolio Mortgage Backed Bond ETF SPMB and SPDR DoubleLine Total Return Tactical ETF TOTL.

Markets

U.S. stock-index futures (ES00) (YM00) (NQ00) are higher early Friday as benchmark Treasury yields BX:TMUBMUSD10Y dip. The dollar index DXY is little changed, while oil prices (CL.1) rise and gold (GC00) is trading around $2,720 an ounce.

   Key asset performance                                                Last       5d      1m     YTD     1y 
   S&P 500                                                              5809.86    -0.54%  1.12%  21.80%  40.43% 
   Nasdaq Composite                                                     18,415.49  0.23%   1.24%  22.68%  46.21% 
   10-year Treasury                                                     4.201      11.90   44.70  32.01   -63.99 
   Gold                                                                 2732       -0.17%  1.91%  31.87%  35.50% 
   Oil                                                                  70.48      2.38%   2.68%  -1.19%  -17.24% 
   Data: MarketWatch. Treasury yields change expressed in basis points 

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The buzz

U.S. economic data due on Friday include durable goods orders for September, released at 8:30 a.m. Eastern, and the consumer sentiment final reading for October at 10:00 a.m.

Companies releasing earnings reports before the opening bell include Colgate-Palmolive $(CL)$, Piper Sandler $(PIPR)$ and WisdomTree $(WT)$.

Apple $(AAPL)$ was downgraded to an underweight at KeyBanc, saying its own survey finds the iPhone SE is not incremental, and could possibly be cannibalistic, to iPhone 16 sales.

Shares of Michael Kors owner Capri Holdings $(CPRI)$ are plummeting 47% after a judge blocked its $8.5 billion acquisition by Tapestry $(TPR)$, whose stock is up 14%.

Deckers Outdoor $(DECK)$ shares are up 14% after the maker of Hoka shoes and Ugg boots delivered results that were better than expected.

Japan will hold an election on Sunday.

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The chart

Trump Media & Technology stock has seen increased buying by retail investors as betting markets show the rising probability of a Trump election victory. "But we wonder whether this will turn into another game of hot potato between pros and amateurs," says Vanda Research.

"DJT has historically been regarded as a 'meme stock"' but now it's increasingly being used by retail speculators as a vehicle to bet on a Trump win at the upcoming U.S. election. Whether or not that proves to be the correct bet in a few weeks' time we suspect that retail and institutional investors will rush for the exits as the outcome becomes clearer," Vanda Research adds.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

   Ticker  Security name 
   TSLA    Tesla 
   NVDA    Nvidia 
   GME     GameStop 
   TSM     Taiwan Semiconductor Manufacturing 
   DJT     Trump Media & Technology 
   AAPL    Apple 
   PHUN    Phunware 
   NIO     NIO 
   PLTR    Palantir Technologies 
   AMZN    Amazon.com 

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-Jamie Chisholm

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October 25, 2024 06:40 ET (10:40 GMT)

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