As the Iran war rattles markets, strategists say there are still plenty of relatively safe sources of yield for income-seeking investors, but they will require foresight. Major stock averages were on track to gain significantly on Friday, with the S&P 500 on the verge of erasing its biggest decline since the start of the Iran war. But the market has been on a roller coaster since the dispute began, with the market-wide index down more than 9% from its peak. Rising oil prices have also raised concerns about inflation, causing U.S. bond yields to rise sharply since the start of the war. Bond yield and price are inversely related. This means that U.S. Treasuries were sold off as interest rates soared. “Given what’s going on with rising inflationary pressures, using Treasuries as a safe haven has become a little less interesting,” said Anders Persson, chief investment officer and head of global fixed income at Nuveen. “Inflation risk is at the forefront right now, and when you add fiscal risk to that, you see this troubling environment where Treasuries and risk assets are sold off at the same time,” he added. Managing Price Volatility To deal with bond market volatility, Mr. Persson emphasizes keeping credit quality high and duration, a measure of a bond’s sensitivity to interest rates, “short to neutral.” Bonds with longer maturities tend to have longer durations and therefore experience the greatest price fluctuations when interest rates change. “We’re focused on the belly of the (treasury bond) curve, which is a little less than 10 (years) and a little more than two years,” Persson said. Russ Brownback, BlackRock’s deputy chief investment officer for global fixed income, said the position close to the “front to belly” of the curve also leaves investors with room to see how the Federal Reserve manages interest rate policy for the rest of the year. “Assuming geopolitical conflicts are no longer open-ended, we think the Fed could cut rates by the end of the year,” he said, adding that his team expects “one or two” quarter-point rate cuts by the end of the year. According to the CME FedWatch tool, federal funds futures trading suggests there is a 75% chance that the December target rate range will still be between 3.5% and 3.75%. “We want to be at the front to the bottom of the curve to reprice the Fed’s rate cuts, and we want to accumulate corporate and securitized bonds to get that yield,” Brownback added. He sets the duration of his income-focused portfolio at about three years. Aim for quality and seek yield According to Nuveen’s Parson, an asset class that looks promising amidst geopolitical risks includes municipal bonds. These bonds are backed by the full faith and credit of the issuer, making them generally a safer investment compared to corporations. “We’re trying to be opportunistic across the entire rating spectrum,” Persson said, noting the firm has done some digging in the below-investment-grade muni space. “Given the geopolitical uncertainty, we think (municipal bonds) should be more broadly sequestered.”The most important feature of municipal bonds is their tax-free interest income, which is especially valuable to high-income investors in high-tax states. “If you look at municipal bonds for high-tax investors, the valuations are relatively compelling, as are the absolute tax-equivalent yields,” said Bill Mertz, head of capital markets research at U.S. Bank. Companies can also offer solid opportunities to discerning investors. “Investment-grade corporate yields are at levels we haven’t seen since the tariff tantrum in the market last year,” said Matt Brzesniewski, head of fixed income client portfolio management at Vanguard. He noted that there is an opportunity to pick up stocks with a 5% yield. In high-risk, high-yield areas of the market, such as leveraged loans and bank loans, investors should proceed with caution, or at least leave the choice to a professional. Concerns about artificial intelligence disruption are putting pressure on software companies, which tend to be big borrowers from private financial institutions. The turmoil triggered a wave of investor withdrawals from private credit funds. “There is significant software exposure in the leveraged loan space,” Nuveen’s Parson said. “Be mindful of the headwinds that AI is bringing to the credit space.” Focus on long-term goals It may be tempting to flee to cash when bond markets are in turmoil, but that would be a mistake, Brzesniewski says. “Panicizing and storing your money in cash is not a very sound strategy and will likely underperform opportunities further down the curve,” he said. Instead, investors should make sure their fixed income allocation reflects their goals and risk appetite. “If you have a long-term view, stick to your strategy,” Wrzesniewsky said. “The market is creating pockets of value.”
