Exclusive Interview: Matt Brill, Head of North American Investment Grade for Invesco Fixed Income
What's next for the bond market in 2023?
Ric Edelman: One of the biggest, most important topics as we go into 2023 is what's going on with the bond market and the world of interest rates and inflation. And to help us delve into that, I'm really happy to share my conversation with Matt Brill. Matt is the head of North American investment grade for Invesco Fixed Income. Invesco is a household name of course. They are one of the largest and oldest mutual fund and ETF companies in the world. You can learn more about Invesco at Invesco.com. So first, I want to level set with everybody. When we talk about the market and market volatility, everybody naturally assumes we're talking about the stock market. But in fact, the bond market is far bigger and far more volatile than the stock market, isn't it?
Matt Brill: It certainly has been more volatile this past year. I think when people set up for bonds, they think it'll be less volatile. And that's why last year was such a surprise for so many people. But it is a lot bigger, that's for sure.
Ric Edelman: Yeah, I think that one of the reasons people assume that bonds are safer than stocks is that there's a maturity date. If you hold the bond long enough, you'll get to maturity and the issuer will refund your money. That isn't necessarily true in stocks. You buy stock in IBM, there's no promise that they're ever going to give you your money back or all of it or any part of it. So that is good to the extent that it exists, meaning if you buy an actual bond, not a bond fund, and if you hold it to maturity and there aren't very many people who are buying actual bonds or holding the maturity, which means they're subject to the same market forces - the market fluctuation, that exists in the stock market. And people really need to get familiar with that fact. You mention your agreement that the bond market is much bigger than the stock market. Elaborate on that because I think that fact surprises a lot of people.
Matt Brill: Yeah. So people don't realize how much debt there is in the world. I think you're surprised. We all hear about government debt, we hear about our deficits, and we keep adding more and more to it to the national debt. But they also don't realize that corporations have debt. You'd be surprised. Apple borrows billions of dollars every year, yet they still have a huge cash balance. Know why would they ever do that? Well, they have certain reasons for building a factory or sometimes they want to buy back stock. You look at companies like Coca Cola, they have debt too. Households, have debt. When you get your mortgage, that all shows up into our market. So there's a lot of different places that debt comes from. And even if people have the ability to pay down their debt, sometimes it's still better for them to keep that debt out there. That cost of capital might be cheaper. You get tax advantages for owning debt. So there's a lot of reasons to own debt. Sometimes it's good. Too much debt is bad. So they have to balance that out. And when we look at the overall market, there's many different places that we can find interesting opportunities for fixed income. And it's not just in government debt, but that's usually what most people are thinking about.
Ric Edelman: Yeah, I have the same attitude when it comes to home mortgages. Even if you have the cash to buy the house - not many people do to buy their first house, but you do to buy your second house because you've sold the first one and you've got all that equity that you roll over to the second house. Many people can afford to pay cash for the house, but in many cases it makes a whole lot of sense to get a mortgage instead, even though you don't have to. And Apple, as you noted, is such a profitable company and has so much cash at its disposal, it's using debt because it's smart business. It's really that simple. So like you said, there's good debt and bad debt. Add it all up for us, though. When you say that the bond markets bigger than the stock market, give me some numbers. How much bigger?
The Corporate Bond Market Now Exceeds $7 Trillion
Matt Brill: So, the corporate bond market is around $7 trillion. You've got about a trillion and a half in high yield, and then you have roughly $20 plus trillion in US government debt. So that's just in the US. That doesn't even include the mortgage space, which is another call. It's another $10 to $15 trillion. So you add it all up, you're looking at somewhere a little less than $50 trillion of US bonds. Then you have to remember that there's also the bank bonds that are coming out of Europe. There's bonds that are in Japan, there's bonds that are in China. So the global debt market is somewhere in the magnitude of close to $100 trillion. I don't have the numbers for the S&P 500, the market cap of that, but it's materially less. And just the amount of trading that happens in the bond market on a day-to-day basis tends to be 2 to 3 times what you see in the stock market.
Ric Edelman: And in addition to its being much bigger on a global basis than the stock market, there are a multitude more issuers as well. I mean, we all talk about in the world of stocks, we talk about, as you just mentioned, the S&P 500. That's 500 companies. But how many issuers of bonds would you say that there are?
Matt Brill: Oh, yeah. There's endless amounts. And some of them are private, some of them are public. So you're generally looking at over 1,000 issuers that will be coming to the corporate debt market, possibly even just any given year. But what I think is even more interesting about it is that if you take Apple, for example, there's one stock for Apple, they have something like 50 different bonds within the fixed income world. So they have a two-year bond, a three-year bond, a three and a quarter year bond, a five-year bond. They even have 40-year bonds. When we say we like Apple or we don't like Apple, that doesn't necessarily mean that we're talking about one particular bond. There are so many different ones of them, and that's often why a lot of individual investors go with a bond fund because they just say, look, there's so many to choose from. Where do I even start? But I just find it more three dimensional because we can buy senior, we can buy a subordinate. We could buy preferred, we could buy one year, three-year, 10-year, 30-year. There's a lot of different ways to buy Apple bonds versus with the stock, there's just one. So to me, that's what's interesting and that's what I find really kind of exciting about the space.
Ric Edelman: And in addition to the fact that there are thousands of issuers issuing thousands of individual bonds, creating the multitude of variety that you mentioned, they vary in, I would say, three major ways. As you noted, Apple stock is Apple stock is Apple stock. That's all there is to it. It's kind of dull and boring. But when it comes to Apple bonds, there are three factors. One, you cited the maturity date. Is it going to mature in two years or in 40 years? There's a big difference between the two that relates to the interest rate that Apple is willing to pay for the bonds at issues and generally speaking, they're willing to pay a higher rate of interest for a longer-term bond than a shorter term. And then finally, is the issue of credit record. What is the credit rating? How safe is this company perceived? Talk a little bit about credit risk and credit ratings and how that comes about and what that all means in the world of bonds.
Three Ways To Drive More Yield in Bonds
Matt Brill: Yeah, So there's generally three ways that you get more yield. One is you get less liquid. So the less liquid, the more private you become, the longer you lock up your money, you can get more yield for that. The second one, you just said, by going further out the curve, a 30-year and 40-year bond should yield more than a one-year bond. But the other option to get more yield is to go down in credit quality and/or down the subordination, but generally just take down in credit quality, go with a double B or high yield rated bond versus a AAA or investment grade single A rated bond. So the more risk you take on, the more you should get paid. Kind of risk return, general balance there. And so what we do with credit analysts and our whole depth of research is trying to figure out is what we're getting paid commensurate with the risk that we're taking of the credit quality of that company. And when the economy is good, you want to take on more risk. When the economy is bad, you want to take on less risk.
Ric Edelman: And unfortunately, though, you often discover that the economy has turned bad after you bought the bond. I mean, look what's going on in 2022 and as we enter 2023. 2020, 2021 were great years. The economy was very robust, the stock market was booming, unemployment rate was very low, inflation was still pretty low, and it was pretty easy for people to get cocky, saying, Yeah, I don't have any problem buying an Apple bond that matures in 40 years because Apple's a great company, hugely profitable. They've got billions of dollars in cash. What's to worry? Well, we can be very confident about buying an Apple bond that matures in a year or two, but who the heck knows what will be going on with Apple 40 years from now? And by then, the company could frankly be bankrupt, not even existing anymore, and that bond could become worthless. So to your point, the longer you're willing to let the company have your money, the more risk you're taking. And that's why investors demand more interest on those longer-term bonds.
Matt Brill: Yeah, that's absolutely right. We actually even have 100-year bonds, believe it or not. So there are some hundred-year bonds that exist. They're generally on rail companies and things like that that people can conceptualize that they might be around in 100 years. But I point out to people, you know, there's two things. One is that there is some liquidity. You know, we can sell these bonds. So if we change our mind, generally we're able to sell them. So that's why we have to keep on top of credit research even after we buy. I want to make sure if something changes, we can sell it, but we really can only forecast 3 to 4 years out. It's really hard to forecast any more than that. And you throw in a pandemic, you know, really you really had no insight into where the economy was going for any extended period of time. But generally, we can only forecast three to maybe five years out. So you start going after that, then, yeah, you need to get paid more money to lock up that or at least take on that risk that maybe you won't be able to sell it or whatever, but that's why you get paid more. I would say in really low interest rate times, people reach for yield because they weren't getting enough yield by buying T-bills, they weren't getting enough anything in their bank account. So they said in order to get a reasonable yield, I have to start going and locking in this money for longer and longer and longer. And what's kind of nice about today's market is that that's sort of switched. So you're not desperate for yield like you were in 2021, which caused some poor decisions or some stretches out of people. But now you're in more of an environment where you can actually get reasonable yields on a historical level just to buy one, two, five-year bonds, which is a great opportunity versus where we've been for several years now.
Ric Edelman: So when you say a reasonable rate of interest in a bond today, turn that into a number, what does that mean?
Matt Brill: Yeah, so a typical bond, you could buy off the shelf, a three- or four-year bond of an investment grade company, you can get about 5%. So, you know, that 5% is kind of the benchmark that you hear people talk about for years. If I could just get 5% by buying investment grade bonds, I probably would, because that seems like a good number historically, and for the last several years, it's been more like one and a half to two and a half. So when we're at this 5% now that you can get by buying three, five, 10-year corporate bonds, a lot of investors are saying, well, that looks pretty interesting. Last year they said, oh my God, I've just gotten crushed and everything I own, I want nothing to do with it. This year, they're sort of waking up and saying it is 5% for this type of credit. The Verizons, the AT&Ts of the world that you've heard of and you say, “Well, these are not stretches to be buying these types of companies, these investment grade companies.” So 5% looks pretty reasonable to us and to them. But again, it was a tough, tough, tough year last year. And so it took a little while to change the mentality of investors. And it's starting to turn over as this year is unfolding.
How Bonds Affect the Stock Market
Ric Edelman: And so let's for a moment digress to talk about the relationship between the bond market and the stock market, because there's a little thread in there I want to pull on. You noted that today you can probably get about a 5% interest rate from a three- or five-year bond. A couple of years ago, you could only get 1%. So go back a couple of years ago. If you could only get 1% in a bond, that was not very satisfying. People were, as you noted, yield chasing. They're looking for alternative ways to get higher interest. And what was really interesting is that a lot of these S&P 500 companies pay dividends. So if you own the stock, they pay you interest - called a dividend, by being a stockholder. And in many of these companies, those dividends are 4% or 5%. So people said two or three years ago, if I can only earn 1% from their bonds, but I can earn 4% from their stock, I might as well buy the stock. And a lot of people argue - and I want you to push back on this and tell me if you agree or disagree with me here, Matt - a lot of people said that this is why the stock market did so well over the past few years because there was no alternative. We called it TINA in fact. TINA - there is no alternative. You have to buy stocks because there's nothing else to buy. Bonds are so low in their interest rate that you might as well buy the stock and get a big stock dividend. Do you think there was any legitimacy to what I just said?
Matt Brill: So I was about to say TINA. So yes, you were on the exact same page here and I get it. So, yeah, we look at the S&P 500 as a whole that has a dividend yield of around 2%. But yes, individual stocks, some of them are 4% or 5%. And those were just automatic, I say, no brainers. But they were generally no brainers to the individual that was buying them, that was the reason to buy it. And we talked to a lot of investors and they said the same thing. Well, if I can get more yield buying a stock, why in the world would I buy a bond? And I said, you're probably you're right. I mean, I get it. You know, the only counterargument I could say to that is that coupons are obligatory and dividends are discretionary. A company can turn off their dividend. They don't have to pay a dividend. They do have to pay the coupon. If they don't pay their coupon, they're out of business. But nobody really cares about that because generally companies don't stop paying their dividend or they try not to at least. But TINA existed and TINA drove everything up. And now there is an alternative. Doesn't necessarily mean that stocks have to go down because of that. But I would say from a competitive landscape standpoint. You're looking at yields, and if you only care about yields, it's much more attractive to buy bonds right now than stocks. That's just a fact.
Ric Edelman: I want to push back on that point that you just made, and I want you to elaborate on it for us. The fact that if there now is an alternative and we all agree there is because you can get bonds at 4% and 5%. And so people who were buying stocks to get that 4% are now going back to the bond market, which is where they came from. You don't think that that will necessarily reduce demand for stocks, that won't reduce the supply demand equation, and won't that put pressure on the stock market?
Matt Brill: Well, I'm a bond guy, so I don't want to sit here and be too biased towards just odds. But I'm not speaking purely of equities. I sort of tell my equity colleagues, but you're going to have less people buying them. It's just math. Now, if that money comes out of somewhere else, then maybe that can supplement it. But yes, if you have the same landscape of dollars, more going to go into bonds now than stocks. You're seeing at an institutional level, pension plans, things like that, they're just taking money out of stocks and putting them into bonds. And they're saying, I'm going to lock in this 5% because I've been waiting so long for it and I'm an income buyer. I need the income and I can get a lot more income here with lower volatility over the long run than I can get in stocks.
Two Key Factors That Impact the Price of Your Bond
Ric Edelman: You made a statement that is really important and I want to elaborate on this as well, because it's one of the things that causes the most surprise, shock, sadness among bond owners. You said that if you own a bond, even if it's a 40-year bond, you don't have to wait 40 years to get your money back. You can sell it in the open marketplace. The question is what price will you get when you sell it? And there are, I think, only two primary factors affecting the price you will get for your bond. One of them is interest rates and the other is credit quality. So talk about interest rates first. How do changes in interest rates affect the value of the bond you own?
Matt Brill: Yeah, so I'll try to simplify this as much as possible. A yield of a bond is going to be your interest rate, your government interest rate plus a credit spread premium. So how risky that is, you've got to get paid more than the US government because the US government's going to pay you back, right? So let's just use an example of 4% on a US Treasury and if you have 100 basis points of credit spread, that's a 5% yield. If interest rates go up at the government level, you multiply it by your duration. So if you have a 10-year duration, which just a large round number, if interest rates go up 1%, you're going to be down 10% on that bond. That's kind of what we went through last year. We had 5% type duration and you moved really about four percentage points. So you take four percentage points times five of the duration. That's 20 points that you move. That's a really big number. Now you get your coupon and that eats into that a little bit. You get other factors that contribute there. But at the end of the day, it's a simple math of duration times the move in interest rates or all in yields that you have.
Ric Edelman: So I want to make sure that the consumers who are listening to us and investors really understand what you just said, because this is the single most important reason why bond buyers get shocked as interest rates go up, the value of your bond goes down. And the more that interest rates go up, the bigger the loss. And the longer your maturity date or duration, the longer your bond is going to last, the bigger that swing. The way I like to refer to it is seesaw. If you picture two ends of a seesaw, you've got interest rates on one end, bond prices on the other end, one goes up, the other goes down mathematically fact. But in the middle of that seesaw, picture a 30-day treasury, it doesn't move very much. Two interest rates because you're going to get your money back within a month. But now go out to the edge of the seesaw to a 30-year maturity that has a really wide fluctuation in value. So as interest rates go up, the value of the bond goes down. And people need to understand this. This is why, to your point, last year, interest rates went up 5%. The Fed raised rates five times last year and those radical increases in rates caused a radical decline in bond prices. Now, as you said, it was offset by the income you were getting from the bond. But at the end of the day, the bond market, 10-year treasuries lost 13% last year, the worst in history. They've never lost as much money as they did last year, and this is why it happened. So people need to ask themselves one fundamental question. Do you think interest rates are going to keep going up? Because if you believe they're going to keep going up, you're basically saying that bond prices are going to keep going down. So what's your take on where we are today with what the Federal Reserve is doing regarding future interest rate increases?
Matt Brill: Yeah, spot on with everything you just said there. The only thing I'll add to what you said is that you do have a larger coupon today so that buffer, we call it a buffer, you know, you're at 5% coupon versus 1%. 1% on that seesaw got eaten into pretty quickly. 5% can still get eaten into, but it's just a little harder. It gives you a little bit more of a cushion there, a buffer.
2023 Playbook: The Fed, Interest Rates, and Inflation
Ric Edelman: Now, where are we on interest rates? So the Fed Reserve, we just had an inflation number come out, here in the US. So inflation is down, it's coming down. It's come down for six straight months at a headline level, but it's still elevated. If you look at the levels of inflation, they're just north of 6% on the headline, meaning including gas and food, and it's 5.7% or just below 6% on core. So it's coming down, but it's still high. And everybody says, well, Matt, 5.7% still looks pretty aggressive to me. I think the Fed's got to be staying at an elevated level for a long time and keep actually hiking. But we say, okay, well, let's peel the onion back a little bit. And if you look at the last three months and annualize it on a headline number, it's 1.8%. So the last three months, if they continued at that pace for another nine months, you would come back at nine months from now and say inflation in the United States was just 1.8%.
Matt Brill: That's pretty good. The Fed targets 2%. So that's actually below their target. But they generally look at core, which excludes energy and food prices, and that annualized is at 3.1%. So that's still above where the Fed feels comfortable, but it's a lot better than where it was because it was around 7%. So we're getting the trajectory better. Inflation is slowing and the Fed is coming out and telling you our hikes are working, but we're not done yet. And so we think the Fed has probably two more hikes in them. They're going to hike. I believe that the next meeting is February 1st and then they'll hike probably another time in March. But those are 25 basis points. So they have been doing 75 basis points and then 50 and then they're going to go to 25. They're kind of just weaning themselves off here, but they're kind of like the eighth inning, I would say. So at the end of the game, the market tends to price in things before the Fed is done. So the market's actually starting to say, look, the Fed is close to being done hiking and they're going to do a good job. We believe that will crush inflation. And then late 2020, 2023 or early 2024, they're actually going to have to start to cut and the market's starting to front run that, which makes for an interesting ride back lower on the seesaw. If we get that to occur.
Ric Edelman: If the Fed reduces interest rates, then the value of the bond goes up, which is great news. And that's what we frankly have had from roughly 1982 through 2009; interest rates steadily went down for a 40-year period of time. Anybody who has been buying bonds over the past 40 years has only seen the value of bonds rise because interest rates have been steadily dropping. What's been going on in the past decade, with interest rates beginning to go up, is unprecedented in our lifetimes. And this is why I think so many people are so shocked to see bond losses because that hadn't happened in the last 40 years.
Matt Brill: Yeah, it's certainly when people pull up in their statements, they say, I thought this was supposed to be the safe part of my portfolio. I'm down in my stocks and in my bonds. And if you combine the two, the traditional 60/40 portfolio, I think was the worst since like 1860 or something like that. So it's been a very unfortunate year and they've been very correlated historically. Bonds rally when equities are selling off because it means that there's a flight to quality. You're running away from your risk assets and equities and you're running to the fixed income market. But what was so rare about 2022 was that the fixed income market was adjusting and causing everybody to realize that the era of low interest rates might be over. It doesn't mean we're going back to the 1980s to 15% to 20%, but this era of basically free money that we had in 2020 is certainly, certainly done.
Impact of the Inverted Yield Curve on Bonds
Ric Edelman: Now. There's something going on in the bond market that is unusual, not unheard of, but unusual. And it's worth talking about because everybody on Wall Street is in a tizzy over it. And you know what? I'm about to be talking about the inverted yield curve. Let me explain for folks what an ordinary yield curve is. You've already kind of referred to it, Matt. We're talking with Matt Brill, the head of North American investment grade for Invesco fixed income. You mentioned that Apple for example, issues bonds that are one-year bonds, two-year bonds, all the way out to 40 year. We know the US government issues. Similarly, they have 30-day treasuries and they have 30-year treasuries. We know that the longer the maturity date, the bigger the risk. Will Apple exist in a year? Sure. But will it exist in 40 years? A little less sure. So investors demand to earn a higher interest rate for a longer maturity. So think about that on a chart. The one year is in the beginning of the chart, the 30 years at the end of the chart. And as you go out to the 30 years, the interest you're being paid rises, that's a normal curve. But we're now in an environment where people are fearful of an inverted yield curve, meaning I'm earning more interest on a one year than if I were to buy a 30-year. Why is that happening and why does it matter?
Matt Brill: Yeah, So it's a great question. And we get a lot of clients that simply say, I just want to own T-bills, I just want to own front-end cash because I can get more and we'll get into why that's maybe not the right decision but let me just explain why that even exists in the first place. So the Federal Reserve is basically hiking overnight rates. The Federal Reserve does not control 10-year treasuries. I think that's one thing people need to understand. The Federal Reserve, they can buy bonds and sell bonds and whatever. But at the end of the day, mainly what the Federal Reserve does is control overnight interest rates. And they've been hiking overnight interest rates because they want to make it more expensive for your credit cards and for banks and everybody to borrow overnight money. And as it gets more expensive, that slows the economy. So they're trying to slow the economy because they need to crush inflation. So the Federal Reserve is going to get to around 5% on overnight Fed funds somewhere between four and three quarters, 5%. We can debate where it goes, but somewhere around 5%, let's just say 5%. But after that, the Federal Reserve is not going to keep it there forever. And at some point they're going to actually lower it. And so if the Federal Reserve is successful and we think they will be in crushing inflation, that means that at some point in the future they're going to actually lower rates because they're needed to get the economy going at a more normalized pace.
If they keep rates at too high for too long, it basically chokes the economy for long enough that we cannot get a normal economy going. People are out of work. And then the Federal Reserve says, uh oh, we went too far. We need to stop pushing the brake. We need to start putting on the pedal, which means cutting rates, getting the economy going. And so there's what we call reinvestment risk. And reinvestment risk is basically, yes, you get access to 5%, but you only get it for so long. And what happens in six months from now, a year from now, when that bond comes due and you get your cash back, what are you going to reinvest in? Are you still going to get 5%? Are you going to get 3%? Are you going to get 2%? We don't know. But what pensions, as well as some individuals are doing is they're saying, “I want to lock in these yields for a long time because I think the Federal Reserve might be cutting in 2024 back to 1% to 2%.” And then we're going to have a 10-year treasury at that really low level. And I won't be able to get these attractive yields for very long. Therefore, I need to lock it in longer now. And that's what's happening. So the idea is that rates are high now, but in the future they'll be low and then it'll kind of average out to this level where the 10-year Treasury is today.
Ric Edelman: And as a result, we have a yield curve where there's an upside-down effect as to you expect longer term to be higher in rate. But in fact, the shorter term for the moment are higher end rate. And that's not common.
Matt Brill: That's not common. And I will point out, though, because you mentioned that we'd been on a 40-year trajectory of lower rates. So you often hear the story of the grandmother back in 1980 that bought her kids or grandkids 30-year US Treasuries. You hear a lot of those stories. I'm sure you have over the years. What a great trade grandma made was absolutely amazing. Grandma locked in at 12% on 30-year US Treasuries. Amazing job, grandma. At the same time, there was 18% Fed funds, so you could have got money market funds for 18%. I have never heard anybody tell a story of their grandmother locking in at a T-bill for three months or six months because yes, you got it for 18% for three months, but then it went away. And so you had to reinvest that at a lower rate and a lower rate and a lower rate for the next 40 years. So that's why there's these opportunities to lock in. Sometimes it works, sometimes it doesn't. But at these elevated yield levels, you kind of have to say, look, that does look pretty attractive. And if I can get 5% to own something for 30 years, I'm okay with that. And maybe it works out, maybe it doesn't. But if you don't, at least do some of your portfolio in that, I think you're missing opportunities, particularly when the market gives them to you.
Is An Inverted Yield Curve a Warning Sign of a Recession or Soft Landing?
Ric Edelman: Now, in addition to this interesting dynamic of this inverted yield curve is what some people regard as a warning that that yield curve is signaling to the broader market. They fear that what that means is that we're going to go into recession. And if you look historically, whenever we've had an inverted yield curve, there usually has been a recession shortly following. So do you feel that this is an effective warning signal that a recession is coming? And if so, when and how severe?
Matt Brill: So it certainly means things are going to slow. The best of times for nominal growth certainly has slowed, meaning if you don't knock off inflation, growth is going to slow. We think real growth could be potentially negative. You could be right on the cusp of a recession. We're calling for a soft landing. We're in a little bit of a minority there. You know, people say, well, why does the yield curve even matter? Well, here's why it matters. If a bank is borrowing overnight at 5% and they're lending at 3%, they're not going to do that. So they stop lending. If you have an inverted yield curve, it becomes harder and harder to get loans. And loans are really the lifeblood of the economy, lifeblood of the financial system. So that's why it matters. That's kind of fundamentally why it matters if it stays inverted for a very long time, we are definitely going to have a recession. I think it's inevitable that that will occur if the Federal Reserve pivots in late 2023 and says, look, inflation's under control. The economy slowed, but it hasn't slowed too bad; we can get this thing back in line. That's what we call kind of a soft landing. That means that the economy doesn't really just get completely wrecked. It's a nice, easy balance. You probably have a GDP of maybe only a half a percent, but it's positive and everybody kind of continues on with a good job market, but it's not as robust as it is today. That's the scenario we're calling for. But if the Fed kind of says we are going to stay at 5% until the last little bit of inflation is crushed, that means you're probably going to go into recession late 2023 or early 2024, which would be good for bonds, but not necessarily good for corporate bonds. It'd be good for Treasuries, because that's kind of that flight to quality that would take place at that time.
Fixed Income Investing Opportunities in 2023
Ric Edelman: So given everything that you've described where interest rates have been, where they are today, where you're projecting they're going to be in the future, is there any particular area in the world of fixed income that is worth investing in today?
Matt Brill: Well, we think there's a lot of places that are worth investing. If you'd asked me a year ago, there was more problems a year ago around inflation. Now I think there's more problems around growth. So I do think that the inflation story, which has been so spooky to bondholders, I think is almost over. It's not quite there. Not ready to declare victory yet, but I think it's almost over now. We have to focus on how slow the economy is going to go. But I think if you buy that 3-to-5-year part of the market, getting 5% high quality investment grade companies, I think that that's a good opportunity. And I think that that's a nice place to be. If the economy heads into a recession, if the economy has a new recession, the investment grade names of the world - and these aren't recommendations, but I'll just use them as references, the Verizons and the AT&Ts and the Apples and the Microsofts, they're probably going to be fine. But if you get into that kind of high yield portion of the market and the economy really does have that slow or that hard landing, you're going to have more trouble there. So for me, that sweet spot is to get a little bit out of that money market, kind of that cash area, go lock in your money for 3 to 5 years at what we think are attractive interest rates. It does have liquidity if you need to pull it out. But I'm just saying go at a little bit of duration to your portfolio, add a little bit of credit risk, not just governments, be more investment grade. And I think that's a 'sleep at night, do well' portfolio that I think is set up for 3 to 5 years and you don't have to take a lot of credit risk now to get attractive yields which I think is the best thing about this market.
Ric Edelman: So you mentioned the phrase high yield. That is a little bit of jargon. I want to make sure folks fully understand what we're talking about here and the inherent opportunities and risks associated with the high yield bond market. When I hear the phrase high yield, my initial reaction is great, why wouldn't I want a high yield? Isn't that the whole point of buying a bond?
Matt Brill: Yes, and there are great opportunities in high yield, but with yield comes risk. So nothing's for free in this world, particularly in the bond market. So we make you pay up if you're a little bit riskier. And so the high yield market is companies that S&P, Moody's and Fitch do not qualify or classify as investment grade, which the lowest investment grade rating is triple B minus. This is below that. So typically institutions, pension plans, etc. are not allowed to buy high yield because they have to have an investment grade mandate. But in the high yield space right now, the yields are around 8%. So they are very attractive. And if you are a believer that the US can avoid a recession, I think you can do very well in high yield. If you're a believer that the US is absolutely headed into a recession, then you need to avoid high yield because the companies that have greater risk there will have greater, greater defaults in 2023 and 2024 as well. So the ability to repay the debt in a tough economy, if that were to occur, becomes harder. And so I think that that's why you have to be a little bit careful in high yield. But again, 8% does make up for some mistakes. It'll make up for some defaults. But you have to be careful there if you particularly believe that the economy is going to have a more difficult 2023 and 2024.
AAA: The Holy Grail of Bonds Issuers -The Significance of Credit Ratings
Ric Edelman: So let me make sure people understand just how significant this is in this scale of credit ratings. You begin with triple A (AAA), that is the very best, very safest issuer, which is, of course, the US government. How many companies have a triple-A rating?
Ric Edelman: That's a good question. So we used to have a handful. These all have been kind of downgraded one by one, but it used to be Johnson to Johnson, Apple, Microsoft. UPS was triple-A but UPS is no longer. I believe J&J has lost theirs. Exxon was triple-A rated. They lost it. I think you're still looking at Microsoft. And Apple might be. So it's very small. Difference between double and triple A isn't a lot, but the triple A was a great club to be in. And then they realized maybe we could take on a little bit more debt. Exxon's was a little different because I think oil prices kind of caused it and they wanted to keep their dividend going. But the other ones just said, look, there's really not a big difference in double A and triple A, I'll borrow a little more debt.
Ric Edelman: And so we need to recognize that triple A is really the holy grail of bond issuers. And it's an exclusive club. So you go from triple A to double A to single A, then you go triple B, double B, single B, and you all have pluses and minuses within all of them too. You have double B plus, double B, double B minus. By the time you get to, as you said, the bottom rung of investment grade, which is triple B minus. Right? That's the lowest level of investment grade. Everything from triple B minus and above, is investment grade considered a safe bond, meaning highly likely that the issuer will repay your principal at maturity date. You're going to get your interest on schedule, you're going to get your money back at maturity. Everything below that, beginning with triple C all the way down to D, which means default. The company's out of business. They're not paying interest; they're not going to repay your bond. The company's bankrupt. Most likely you referred to them as high yield. But there is another phrase, and that is speculative grade. And if people realize that they were taking a speculation on their bond that I think they would often be shocked.
Matt Brill: Yeah, and you need to get paid for it. If you're not getting paid for it, then you're out. You should even be more shocked, that's for sure. I always like to give names just because I think it gives context to things. In the triple C space, which is the lowest portion of high yield, you're not going to really know any of those companies. You're probably not going to most of them. But in the double B space, Netflix is rated double B, Ford is rated double B, Occidental Petroleum, Delta. So there's some companies that are household names that are in that high yield zip code. Now, they don't yield the same as Coke either. So generally, the more you know it, the more that the retail advisors might buy it. But it's not all toxic, but it certainly is more risk. And I think that that's kind of the key thing you have to point out is that there's a lot more risk there and they're there for a reason. They have problems, they have a lot more debt and generally they're more susceptible to an economic downturn as well.
Ric Edelman: So with all of this, we have so much confusion. I think for the ordinary individual investor, so many things to think about. You begin with the premise that the investor says, yes, I want to own bonds, I want to have some of my money in a fixed income investment rather than the stock market, rather than the real estate market, rather than the crypto market. I want a portion of my money in bonds, and for most investors it's a pretty big portion. You know, it's 30%, 40%, 50%, 60% of their total investment portfolio. So it's a big decision of buying bonds. And as soon as you say, okay, I want to buy bonds, the question now perks up. What bonds do I buy? Do I buy a bond issued by the US government or by a major corporation or by a municipal government, a state government or a county or a city or a local municipality? And once I make that decision of who's the issuer, then I have to decide what's the maturity date that I want to buy? Do I want to buy a one year or a 10 year or as you said, some of them are issuing 100-year maturity dates. And then once I decide on the maturity date, I have to decide the credit quality. Do I want to buy a triple A bond or a double B or a single? See, my head's exploding. How do I do this? And every time I buy a bond and it comes to maturity, that means I get my money back and I have to make the decision all over again because I've got the cash in my pocket and I've got to reinvest it. So my goodness, what a nuisance. How can investors have it both ways? I get the bonds that I really want to own without the hassle of having to build and pick a bond portfolio.
Matt Brill: Well, you just described why I have job security versus AI at the end of the day. It's a very complicated market and there will always be a need for a bond manager because there's just so many different things out there. You know, there's opportunities within the SMA world, separately managed accounts. You can buy a portfolio and they basically put it through a paper shredder and you own the physical bonds. That's one way a lot of investors do it. And then if you don't want to have it be managed by the manager, you just take your bonds and you have them off on your own. In Invesco, we have something called BulletShares, which is basically you pick a year of the maturity. You say, I want it 2025. We buy 300 plus bonds for you in that exact year. As they mature, we roll it out to the back half of the year and then eventually you just get your cash for it. We also have actively managed accounts. We have actively managed ETFs; Invesco Total Return Bond Fund (GTO) is one that we manage. We have actively managed mutual funds.
So you can kind of give it to us and let us manage it, or we can say use the SMA and you kind of control it. Use the BulletShares where you can pull the maturity. There's a lot of different ways to do it. I mean, at the end of the day, you know, talk to your advisor, ask them what they think is the best way to do this. It's not easy and it can be intimidating. And I think one thing we don't want, though, is people to not buy it because they don't understand it. We want them to get educated on it. It's not as intimidating as it seems. It's like going into a fancy restaurant or something and you're ordering all these things at once. And once you've done it, once you realize, Oh, this is pretty easy to do. But the first time you do it, you're intimidated. So ask questions, ask of your advisor. There's a lot of instruments out there and obviously listening to podcasts like this help you get educated on how to be involved in the bond market.
Ric Edelman: And talk about how an investor would access the bond funds and investments that you mention your separately managed accounts and your Bullets and so on. How do they access Invesco directly through Invesco.com or through their financial advisor? Whichever way they prefer?
Matt Brill: Yeah, whichever way you prefer. Generally through your financial advisor. There's a lot of research out there on the Invesco website. My team manages GTO just like the car. That's an actively managed ETF. It's kind of a catch anything bond fund. It's basically, I want to own bonds, Matt. Here you go. You run with it and you do what you can with it. And that's kind of where we figure out where most investors lie is they simply know that they want to quality. We have framework around how much quality is in it, how much high yield, how much speculative is allowed in it, etc. Let us manage it for you. But again, if you want to manage it on your own, there are so many different options out there within the municipal space as well. And Invesco's really, really strong in that space. And given that tax rates are probably not going down anytime soon, you know, the municipal space makes a lot of sense as well for investors looking for income, but also not having to pay it all to the government.
Ric Edelman: It's been a fascinating conversation. I really appreciate it. Matt, thank you so much. That's Matt Brill. He's the head of North American investment grade for Invesco's fixed income department. And you can learn more from your financial advisor or also, of course, directly at Invesco at Invesco.com. Matt, thanks for joining us.
Matt Brill: Thanks, Ric. Appreciate it.