Welcome to the first periodic update from your FNB Wealth Management Investments Team. These brief updates will cover changes to our portfolio positioning as well as general themes underlying our current strategies on an as needed basis. For this edition, we will focus on our valuation dashboard, which will be a permanent fixture in these publications. While these simple statistics don’t always tell the whole story, they give us a good picture of where we currently stand.
First, let’s focus on bond spreads, which show us the additional yield we can earn by taking on additional risks. There are two primary types of spread, term and credit. Term spread considers the additional yield earned by buying a long maturity bond versus a short maturity bond. Buying a long maturity bond locks in our yield for longer, which is good if future interest rates are the same or lower. However, if interest rates rise or inflation increases, we may wish we had bought a short maturity that could then be reinvested at higher future rates.
For our dashboard, we compare the two year treasury bond to the ten year treasury bond. Right now, locking in the eight extra years of maturity produces an extra yield of 0.3% per year, which is quite a bit lower than the historical median of 1.2%. The second type of spread that we monitor is known as a credit spread. Credit spreads tell us the additional yield (above a US treasury bond) that we can earn by taking on credit risk, i.e. the risk of the issuer defaulting on bond payments. Our dashboard looks at two such spreads, the AA and BBB spread for a US corporate bond index. The AA spread gives us an idea of where high quality bonds are trading and the BBB spread gives us an idea of where somewhat riskier (but stil investment grade) bonds are trading. While both have improved a bit year to date, they are currently lower than their historical medians, meaning we are not getting paid as much today to take credit risk.
As these indicators suggest, we have shortened maturities and increased credit quality in our wealth management accounts. In our next edition, we will cover stock market indicators and how they shape our expectations for future market returns.
If you want more information, contact our Wealth Management team.