MAKING CENTS: With Fixed-Income Investing, Be Prepared to Act

For many years, debt of the United States of America was frequently referred to as the “risk-free” return by the media and investment analysts when compared to other asset classes. But if you’ve had money invested in U.S. government debt this year, you may have noticed that the value of those holdings is actually down so far this year. Fixed-income investments generally fall in value as interest rates rise, and that is why your fixed-income positions dropped this year.

The big question is what will happen next year. The real answer is: who knows? Today I’ll outline the case for both sides of the debate.

The debate topic is whether fixed-income will be a reliable place to dampen volatility in your portfolio and provide some return that may exceed what you can earn from a bank account.

Starting with the unfavorable side, many fear fixed-income investments from a simplistic point of view: that what goes up must come down, and vice versa. Historically, interest rates are still low despite the rather substantial rise we’ve already seen this year. This creates the wide-open possibility of further rate hikes in the near term. Compound this with the $85 billion in stimulus money being pumped into our economy and the case for rising rates sounds plausible.

Ultimately, supply and demand is a huge factor in determining the price of a given investment. If people are lined up to buy it, such as we’ve seen lately with initial public offerings where the new public companies have no profit, prices will generally rise. If there are more sellers than buyers, prices will generally decline. Demand for U.S. debt has been robust. This demand has been strong from foreign investors whose currency and economies were crumbling and from U.S. investors who are simply scared to go anywhere else with their nest eggs. But much of the foreign interest has come from China, which is the largest single holder of U.S. debt. There has been a lot of noise about China severely slowing its purchases of U.S. debt, which could materially weaken the demand for the debt and possibly drive rates higher.

On the other hand, many economists still consider the economy in dismal shape, as evidence by unemployment, the lack of bank lending, the unimpressive GDP growth (still under 2 percent) and the reality that $85 billion a month isn’t doing much to help those of us on Main Street. The actions by the Federal Reserve Bank helped prevent a second worldwide great depression, but these actions are currently in question as it relates to what you and I need on a daily basis. Jobs and access to credit have not improved, leading many to conclude that rates must stay low to stave off the most feared economic condition of all – dis-inflation or falling prices.

Whichever side of this argument you favor, the message here is to pay attention and be prepared to act.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. John Napolitano is a registered principal with and securities offered through LPL Financial. Member FINRA/SIPC. He can be reached at 781-849-9200.