With the benefit of a few weeks perspective, it's clear that the Brexit vote in late June was a key catalyst for the recent nosedive in sovereign bond yields, and especially the U.S. bond market. The stunning decision by the majority of U.K. voters to leave the EU has created more risk, and global investors are showing they remain risk averse as they pile into U.S., Swiss, German and even U.K. government bonds (due to expectation of further interest rate cuts).
The yield of bonds, of course, has an inverse relationship with price, so as the demand for a bond increases, the yield decreases.
Although there has been a bit of a "dead cat bounce" in global sovereign bond yields since the Brexit-induced sharp drop in late June and early July, U.S. bonds saw the smallest bounce, and bond market analysts say that U.S. treasury yields remain under pressure as foreign investors continue to flock to safety. Consider the following:
U.S. 10-Year Treasury Note Hits Record Low After Brexit Vote
A U.S. 10-year Treasury note yields hit a record low of 1.367% in the days after the Brexit vote. The 10-year note yields had been gradually increasing (as high as 1.7%) prior to Brexit as the general expectation was that the Fed would continue to gradually hike U.S. interest rates. In the several weeks since Brexit, the yield on the 10-year note has crept back up to 1.55%.
Global Investors Seeking Higher Yields Flocking to U.S. Treauries
Also remember that ultra-low interest rates globally mean that U.S. treasuries are rapidly becoming the only option if you want low capital risk and a yield above 1.50%. Moreover, it's becoming increasingly clear that the macro trend of foreign investors buying U.S. treasuries that has been in place since 2007 has strengthened again with a post-Brexit flight to quality.
This intense global aversion to risk is not good news from an investor's perspective. With sovereign bond yields worldwide remaining at record lows, the choices for a relatively low risk investment that pays 5% or more are precious few.
Low-Risk Alternatives Offering Higher Yields
That said, there are always opportunities to make money in today's financial markets. The key, of course, is determining the risk involved in an investment, and making certain your anticipated rate of return notably exceeds that risk.
Utilities are in a sweet spot right now, and high-quality utilities that have shown strong dividend growth over the last few years should be a relatively safe place to park your money for at least the next few quarters. If the stock market continues its strong run, you could enjoy upward price movement as well as a substantial dividend. However, as with any stock, there is also risk of a price decline if there is a notable correction in the equity markets.
The key tailwinds for the utilities sector are cheap oil and gas prices and the decommissioning of coal plants supporting electricity prices in several areas of the country.
Investors considering mortgages as an alternative investment have a number of options today. Mortgage REITS (MREITS) have been around for some time now. These firms borrow money and buy mortgages. The idea is to borrow at low short-term rates and buy long-term investments, so you produce a healthy profit over time with your mortgage payment income stream. MREITS are, however, interest-rate sensitive, as their profits are the difference between what they pay to borrow and what they make lending.
You can also invest in mortgage-backed securities. Mortgage-backed securities are like bonds that are backed by the income from pools of homeowners making monthly mortgage payments. Private firms and government-sponsored entities such as Fannie Mae, Freddie Mac and Ginnie Mae all offer mortgage-backed securities. MBS are easy to buy, easy to sell and many offer generous returns. Remember there is a risk of defaults, and that you may get your money back sooner than anticipated if homeowners pre-pay their loan.
Direct mortgage (or hard money) lending is another option, and here your investment is secured by the property. Larger investors have worked with private mortgage lenders who act as "matchmakers" for the home buyer and investor. The peer-to-peer lending revolution of the last eight to 10 years has also spread to mortgage lending, opening up opportunities for investors to purchase fractional mortgage loan participations.
Top-Rated Corporate Bonds
You might also consider top-rated corporate bonds if you are looking for higher income with minimal risk. Corporate bonds are secured by the assets of the firm and must be paid first in the event of liquidation or bankruptcy. Although yields on the bluest of blue chip corporate bonds are only a point or so higher than treasuries, you can find 3-4% yield on the 10- and 20-year bonds of a number of well-managed, highly diversified firms.
So if you expect U.S. and global economies to muddle through the current doldrums back to growth in the next year or two, you may want to consider diversifying by buying a few bonds of well-managed firms in sectors such as mining and retail that are likely to benefit from economic growth.
Given that U.S. treasury yields are not likely to start moving up for at least a few more quarters, individuals who would like to make more than 1.5% interest a year on our investments must move to higher-yielding, but almost equally secure alternatives. Replacing some of the low-yielding treasuries in your retirement portfolio with select dividend-paying utilities, secured real estate investments or blue chip corporate bonds could easily double your overall return over the next couple of years.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.