Evening Brief – 10.02.01
Under the Rocks
Whether the Federal Reserve is correct or incorrect, it appears to be betting that inflation will remain above its 2% target for some time. Fed Chair Jay Powell acknowledged the economy has been more resilient than predicted and said if it proves to be stronger than projected, the central bank will need to do more to return to 2%, because as he recently said, “we will get back to 2%.”
The ever-evolving interest rate saga has taken the US 10-year Treasury yield to 4.70% as of Monday, with the long-term overhead technical resistance at 4.75%/4.80% being challenged. The 2-year Treasury yield, meanwhile, is hovering just below its recent cycle high of 5.20%, putting the closely-watched 2s/10s yield spread at –44 basis points.
The narrowing spread means a lesser probability of recession, but the market is more concerned with the worrying spike in short-term rates to more than 5% for maturities ranging from one month to two years.
Considering these developments, investors looking for inflation-resistant income with inflation-beating returns may need to explore beyond traditional high-yield debt. Business development loans are one area that is performing well in terms of both high yield and capital appreciation.
Several business development companies’ (BDC) stocks are trading higher because of holding portfolios of variable rate loans pegged to LIBOR or SOFR rates, which results in more revenue when the Fed raises the Federal funds rate.
BDCs, like REITs, must pay out 90% of their net income as regulated investment companies (RICs), with a few exceptions. They can boost yield by utilizing leverage and derivatives.
As a result, there are a few really well-managed BDCs with yields of 10% or more. Van Eck’s BDC ETF pays 10.6% and includes some of the sector’s best-performing BDCs.
Since the middle of September, it appears that nothing has been working in some of the most favored sectors; however, there are a few notable exceptions that are not only holding their own in terms of effectiveness, but also delivering returns that can meet and beat both inflation and taxes on an income and total return basis.
That’s a difficult combination to find in today’s market, but sometimes you need to look under the rocks.