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Are There Any Places Left to Find Income?

Russ Koesterich, CFA of BlackRock

An Expert’s Guide to Market Volatility

(Continued from Prior Part)

3. Are there any places left to find income?

According to Bloomberg data, bond yields are pretty much exactly where they started this year, while recent volatility has pushed back the likely timing of a Federal Reserve (or Fed) rate hike. This environment only exacerbates a problem that investors have been struggling with since the financial crisis: Where can I find income? Most recently, with the energy sector singled out for special punishment, I’m getting a lot of questions about mid-stream Master Limited Partnerships (or MLPs) as a source of yield. My answer: I see relative value in US high yield, tax-exempt bonds, international dividend paying stocks and preferred stock.

Market Realist – Where to find yield today.

The US has seen monetary accommodation since the financial crisis, including near-zero funds rate, as well as the QE (quantitative easing) program, in which the Fed aggressively bought Treasuries (TLT) and MBS (mortgage-backed securities) in three rounds, which ended in October 2014. This pushed the yields on the ten-year Treasuries (IEF) from 4.6% post-crisis to their current yields of 2.1%. Yields troughed at 1.5% in 2013, before the Fed announced the tapering of the QE program.

This started the quest for yield for the yield-thirsty investors, leading them to riskier assets like equities (VTI) and high-yield bonds (HYG). The yields on long-dated Treasuries are likely to stay low due to the lack of supply and the demand from international investors. Currently, there is only a handful of places left to find income.

The recent thrashing in the US high-yield bond sector has restored some value in the segment. However, ~15% of high-yield bond issuers belong to the energy sector (IYE). This sector is bleeding because of low crude oil prices, which could drive junk bond yields higher as defaults rise. However, this segment should represent a buying opportunity down the line, as markets tend to overreact.

International dividend stocks do offer some value. The iShares International Select Dividend ETF (IDV) has tanked by 13.4% YTD, which makes it far more attractive currently. The ETF provides ~33% exposure to Europe, which is the place to be when it comes to dividends. The combination of falling stock prices and higher payouts is making European stocks the darlings of the dividend world.

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