The Golden Age of Income

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I like to reiterate this idea. We're calling it the golden age of fixed income. It's really the golden age of income. There is definitely uncertainty today. That kind of slowdown does not dent credit quality in the fixed income market.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Russ Brownback. He's the co-portfolio manager of the $41 billion BlackRock Strategic Income Opportunities Fund. He's going to talk to us today about why he believes we're in the golden age of income, even though fixed income took a hit this past week. You know what looked pretty golden was gold. And Bitcoin. Bonds, not so much. But Russ sees that as an opportunity. We'll talk about it. Listening in is our audio producer, Alexis Moore. Hi, Alexis.

Hey, Jack.

I want to talk about the ruckus in the bond market. I've got all the sober, serious financial news. There seems to be a disruption in my news flow about what's going on with light, fluffy stuff and pop culture stuff. What is the latest? What's going on this week in the rest of the world that I need need to know about?

Well, Beyoncé is bringing her Cowboy Carter tour to the New York area.

Okay, what else you got?

It's not enough? Okay. Um, our sibling publication published an article entitled "The NFL's War on Butts Is Over: The Tush Push Survives." The Tush Push?

The Wall Street Journal? Yeah, I saw that. It's, uh, the Tush Push is where— it's a Philadelphia Eagles thing where a bunch of guys get in a big pile and push each other for 1 yard. When they need a yard, they push each other.

It's only the Eagles?

I think the Bills do it.

I read this story. I think you need to have a quarterback who can squat a lot.

That seems to be an important part of it. Okay, push push is good. What else you got?

That's about it. There's an article in The Atlantic from early May that asks, is this the worst ever era of American culture? American culture, question mark?

Just American culture in general?

American culture.

Wow.

The author, I think, is questioning that claim, but apparently that's the consensus view.

Do they know that there's a Mission: Impossible movie for Memorial Day weekend? I mean, what are these people talking about? Okay, well, I feel like I'm more in the know now, so thank you.

You're welcome.

So look, it's not great what has been happening in the bond market. If you hold longer issues. There's an ETF out there called iShares 20+ Year Treasury Bond that has lost close to 6% since the end of April. Okay, 6%, no big whoop, but that's not what people buy bonds for. They buy bonds for safety. The selling ramped up this past week, and that appears to be directly related to budget negotiations. Also this past week, stocks fell, gold rose, and Bitcoin rose kind of a lot. The move in Bitcoin is really remarkable. Since the end of April, that's up 17%. Last I checked, it was over $111,000 per Bitcoin. It's really a bizarre state of affairs. Investors are selling long US Treasuries and buying Bitcoin in the search for safety. I mean, it's not really a one-for-one thing. These aren't the same investors necessarily. The bond market is reacting to a budget deal that worked its way through the House of Representatives and is now headed to the Senate. It doesn't seem to show any meaningful attempt to reduce the deficit. Here's what one strategy from Macquarie wrote: even if the inability to reduce the deficit in the U.S. doesn't lead to default, a large deficit still implies greater bond supply and perhaps eventual inflation as the debt is monetized to avoid default. Either way, it makes nominal fixed income instruments less attractive as long-term investments. So that explains some of the selling in long treasuries. The 30-year bond, if we go back to the end of April, the yield there was 4.66%. The last yield I have is 5.08%. That's a significant move in a short amount of time. The Bitcoin move, I don't know if you could say is directly related to treasury weakness. There's another piece of legislation working its way through Congress. It's called the Genius Act.. It has to do with stablecoins. It does some basic rule setting and crypto fans see it as a sign that the US government is opening the way for further crypto adoption. As I've said before on this podcast, I don't really connect the two. I don't see how something being more widely used as a financial tool means that its price should be much higher. I would think almost the opposite, something that's going to become more of a financial utility should have more of a steady price. I think the people buying Bitcoin now are buying it because it has gone up, and so they think it's going to go up more. I also think this could be part of what we talked about in this podcast several weeks ago, what JP Morgan coined the debasement trade. People are worried about deficits. There have always been some talking heads out there that might have been fans of gold and buying gold, fans of crypto and who've talked about these deficits are worrisome and we're going to have some sort of bad financial event and you're going to be glad that you hold these things. But now what we're seeing is institutional bond investors are starting to say not quite the same things, not quite to the same degree, but they're saying enough is enough. If you're not going to do anything about these deficits, we're going to demand higher yields on long-term bonds to make up for what we think is going to turn into hotter inflation down the road. I don't really know what it means next for gold prices or Bitcoin prices. Those are very behaviorally driven. But I wanna caution investors against extreme binary thinking here. In other words, either bonds are the thing that's supposed to provide ballast and safety in my portfolio, or I should abandon them altogether and go into one of these other asset classes. I think if anything, the rising yields in the bond market are a sort of self-correcting mechanism. If these bonds are becoming riskier, you need more yield and you're getting it as the prices fall. If you want to put a small portion of your money in gold or crypto on a bet that those things are going to continue to rise in price, fine. I'm just someone who thinks of the word return literally, as in something should be returned to the investor. And I think that whatever theoretical support bond prices are supposed to provide for a portfolio, bond yields, in other words, income flowing into the investor, that can be a source of comfort during periods of financial turmoil. But maybe investors should do things differently now, given the weakness we're seeing on the long end of the yield curve. I wanted some thoughts on how exactly to approach bond investing now. So I reached out to Russ Brownback. He's the global head of macro positioning for fixed income at BlackRock. He's also the co-portfolio manager of something called the BlackRock Strategic Income Opportunities Fund. It's got a gold rating and a 4-star rating from Morningstar, has just over $40 billion in assets. I asked Russ about going long versus staying short, what to think about taking on more credit risk. Which parts of the bond market are most attractive now, and how good of a deal bonds are relative to stocks. Let's pick up with that conversation now. You're just the guy we need to talk to to figure out what to do about bonds. Could you give us a quick overview of, you know, what you see when you look across the bond landscape right now?

It's an incredible opportunity for income. And, you know, for many, many decades, the fixed income regime was more about duration, getting kind of the rate beta trade right. And you had a secular tailwind to price appreciation just through falling yield. You think about the 10-year note falling from around 16%, hard to believe, you know, in the early '80s to about 60 basis points in the depths of the pandemic. And so along the way, you know, you had that tailwind of price appreciation, but you also had kind of duration as a hedge for your portfolios because much of that price appreciation came during sort of crisis modes. And so if your equities weren't doing well for you, your bonds were a built-in hedge to your portfolio.

You almost couldn't go wrong. You're getting these fat yields, you're getting the price appreciation as yields broadly fall. It was a beautiful time, I guess, to be a bond investor for decades, right?

It was. And particularly as it pertains to your 60/40 portfolio, your, your 40, your fixed income did its thing for you. And today it's a very different regime. Because you don't, you have flatter curves than you did prior and nominal yields certainly higher than the last decade. And because you have these uncertainties, we've been cycling through, you know, bouts of uncertainty. This year is no exception. You can't make a sort of directional bet on the beta of rates, whether they're going to go up or down. But what you can do today is harvest these very attractive nominal and real yields particularly when you add corporate and securitized credits on top of the risk-free assets.

Okay. So when you say a flattish curve, for the benefit of people listening who might not know, you just basically mean that you don't get that much more yield going out to longer bonds than you would staying in shorter ones, right? So how do you figure where to be, whether to go long or short, or is it just a diversified portfolio? What do you make of, of that right now?

Yeah, so, you know, you think about what your risk-adjusted returns are, and you can look at either historical volatility or implied volatility in the rates market. The options market will tell you what it's implying over the next year in terms of the price moves for various parts of the yield curve. And so if you can get, you know, in the low 4s at the front end of the rates curve versus high 4s in yield at the long end, but do so with a fraction of the volatility, it's a higher Sharpe ratio trade. It's a more optimal portfolio if it's comprised of those front-to-belly assets. 'Cause like I said, you get almost all the yield without all that implied volatility.

You mentioned a moment ago about how bonds had done their job in the past as a hedge for stocks. I have noticed, I'm not the only one, everyone has noticed that there have been moments this year where stocks and quite safe bonds, treasuries, have fallen at the same time, which has investors rattled. They don't quite know what their hedge is supposed to be. What do you make of that going forward? Do bonds still provide you the right kind of protection to offset your stock risk?

So I'd say a couple things, Jack. One, you know, your ballast today is not the duration, it's the income. So, you know, the very high yields today, are kind of that cushion to your portfolio. And you're right about the correlations having flipped to positive more recently, and that will likely be a feature of the fixed income markets as long as inflation is above the Fed's target. And it means their ability to react, you know, to a crisis in markets is less than it otherwise would've been if inflation were at or below target. Now, that's not to say that if there weren't another crisis, heaven forbid, that would come along, that the Fed wouldn't ease. They would. And in that instance, the front end of the curve would do very, very well following, you know, the policy rate lower. But today, as you kind of ebb and flow back and forth from one data point to the next, the correlations have exhibited that positive relationship. And so that's right, you can't count in the moment on duration as a hedge.

Interesting. So the income, I guess, meaning, you know, it's nice if you're looking at your, the value of your portfolio and it's not moving in the right direction and you can't count on the asset prices to be where you want to have that stream of money flowing in. I guess that, that helps, um, you know, both to put you in a better position financially, but also I would think it's just comforting.

Absolutely. Absolutely. In fact, uh, Jack, we have a metric we call a carry breakeven, and what we look at is the amount of sort of rate shock that one could absorb in a portfolio or in an individual asset and earn the carry over 1 year that would earn you back that price loss in the short run. And so today with yields very high, you have to, at the front and the belly of the curve, you have to have rates move up demonstrably from here before you're in a situation where you've eaten through that 1-year's worth of carry. And so that is your ballast in portfolios today.

Got it. What does the recent downgrade of the US government as a debt. What does that mean for investors? Anything in practical terms, or is it just something that's, you know, just a milestone out there?

So I think it's a milestone. I think it serves as a timely wake-up call as policymakers are endeavoring to, you know, get through this reconciliation process. And we do, you know, face large deficits today. And so I think, you know, it's another signal to policymakers, you know, that it's time to sort of get to a more sustainable stance on deficits. I don't see it, you know, as an event in and of itself that's, you know, shock-inducing, but more symbolic of kind of the trend that we've been on.

So what I hear so far is that bonds look attractive, the yields are high enough to offset whatever risk we have of, um, you know, of yields rising. I mean, you're getting paid enough for the risk you're taking in bonds, and you don't necessarily have to go too far out on the yield curve. You can stay short in bonds and pick up plenty of yields. First of all, tell me if I've I got that right so far. And now I wonder about credit risk. Does it do me any good? Should I just stay in the safe stuff? Does it do me any good to take on extra risk? And if so, to what point? What are the most attractive areas of, of the, you know, non-AAA?

I guess, I guess we have to include the treasuries in that now.

But the, you know, the, the, of this stuff that's a little riskier, what are the most attractive parts?

Yeah, okay. So, and first let me just say, you know, I wouldn't characterize all bonds and throw them into that sort of framework. Not all All bonds were created equal. The front to the belly of the curve, again, you get the yields without the volatility. So you think about the 30-year Treasury and you look at what options markets are implying today. It yields about 4, but right around 5% today. The options markets are implying that could trade in a 15% price return over the next year. So I don't think that's enough compensation, you know, to own that asset. In contrast, so what we're doing with our multi-sector portfolios in a diversified way, putting corporate credit, securitized assets in that front to belly of the curve. And when you do, Jack, you can get a 6.5% to a 7% portfolio yield. You're diversified, it's investment grade rated on average, and your long-term volatility is less than 3%. So it's a multiple of yield to volatility rather than a fraction of yield to volatility.

Interesting. And in terms of taking on more risk on other types of issues, I mean, Beyond treasuries, what other fixed income securities look attractive right now? If you had to rank them, what are your favorite parts of the bond market versus least favorite? Or we can open that up to other income vehicles, whatever it is that you keep an eye on.

Yep. So, you know, underpinning what I'm about to tell you is that we are very constructive on fundamentals, notwithstanding you know, near-term stagflationary shocks, notwithstanding uncertainty that can dampen velocity in the economy. But from a credit quality perspective, the markets are very healthy and corporate America is very, very healthy. And so what we then are doing, looking holistically at the credit markets, saying, okay, the backdrop is healthy, where is the right value in the moment? So corporate credit in general is okay from a credit quality perspective. Investment grade, super high quality, credit has rallied all the way back from its spread widening from early April. So we have really reduced our exposures there. Instead, for corporate credit, we like the high yield market, particularly the BB part of the high yield market. And that's, again, across different industries and the like. The high yield index is a very, very high quality version of itself, certainly versus previous decades. So we like the characteristics there, very attractive yields, Technical are very powerful. There's a relative scarcity of credit assets today that really makes us feel comfortable. In terms of high-quality assets, we like agency mortgage-backed securities over investment-grade credit. We think of those two oftentimes as interchangeable in the high-quality space as both being very liquid expressions. The mortgage market is cheaper today on a nominal spread basis because the volatility in the rates market is high and mortgages are negatively convex, meaning if you have a home mortgage, you could call that mortgage anytime rates are to And that requires a little bit of an extra premium there. We think it's enough to warrant owning those securities. So we like those as a proxy for high-quality credit. And then, Jack, the securitized markets, non-agency mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities, and consumer loans, private consumer loans, we find a tremendous amount of opportunity both for yield and for dispersion.

Thank you, Russ. Let's take a quick break here. We'll be back with more of our conversation about the bond market.

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Welcome back. A couple of quick follow-up questions that have occurred to me about the Beyoncé tour. It's called Cowboy Carter, correct?

Who's Carter? Beyoncé Giselle Knowles Carter, the name that she took, um, as she married Jay-Z.

His name was Carter?

Yeah, Sean Carter.

Oh, I got you.

Okay.

Yeah, so it's not— so I thought Cowboy Carter was like a fictitious cowboy. Okay, so, and then cowboy because it's country music? Correct. Is it just me or is country music picking up in New York City?

No, that's true. I went to a line dancing night recently.

Really? Where?

Brooklyn?

Yes.

Uh-huh. And did the people there look like they know what they were doing? I mean, when it came time to do the line dancing, did the people have the moves down or did they look like they were, you know, just New York City people who were trying to act like, you know, maybe Nashville people or something?

No, it was, it was serious. There were cowboy boots, there were fans, there were moments I had to get off of the floor because the action was too intense.

Oh, that's, that's really something.

I do find myself listening to the Outlaw Country channel on the radio in the car. I think it's like, it's kind of older songs and every song involves drinking or someone going to jail. That's the outlaw part of it. But I'm not doing line dancing in Brooklyn though. I know my line and it doesn't include line dancing. Let's get back to the bond market. How would I say that in outlaw country terms, Alexis? Fixing to talk fixed income? Or pick up some yield?

Oh, okay.

Come on, don't pander. That's pretty good.

How about we Brooklyn boot scoot back to our fixed income discussion with Russ from BlackRock? Can I get a yeehaw?

Mm-mm.

I knew I was asking too much.

Good for you.

Boundaries. Let's get back into my conversation with Russ Brownback. You mentioned high-yield bonds. You mentioned double-B-rated companies. What's a company like that look like? I mean, describe a typical one to me. What is it that keeps them from being at a higher rating for now? And what is it that makes them, you know, still a pretty good bet for investors?

Yeah, so I'm going to answer the question broadly speaking from the high yield index perspective. So, you know, if you go back 20 years, the high yield index composition of BB credits was about 35%. Today it's over 50%. 20 years ago, the CCC part of that market was a quarter. Now it's down around 10%. So the overall quality of the index has improved. And another point that I made before, and I want to give you what's going to be your favorite cocktail party statistic going forward.

I love it.

I'm ready for it. The entire high yield market capitalization, 2,300 companies, is $1.4 trillion. The treasury market grows by that much every 9 months because of deficits. Okay. And so the relative scarcity of these assets, we live in a world of too much money and not enough yielding assets today. And so credit spreads may be tight, but the all-in yields of these very high high-quality credit assets today supported by really powerful technicals is really what gives us comfort.

In fixed income, you know, if we're talking about stocks and we're talking about large-cap US companies, then I would say, boy, investors have been pretty well served by their cheap stock index fund in recent decades. And yeah, maybe, you know, you can make a case that, okay, now things are going to be different. Now it's going to be more about value stocks. Now it's this Maybe, but you know, the record has been pretty solidly in favor of those indexes. What does it look like in the bond universe? Is it because the indexes, it's a little strange, like sometimes they weight issues by the amount of debt outstanding, which you would think would be a negative thing, not a positive thing. So I guess the question is, how does it compare being a bond manager trying to beat an index in the bond world versus the large-cap US stock world?

That's an excellent question. And you know, the broad equity indices are market-cap weighted. And so if you're a passive investor in say, you know, the S&P 500, you are constantly reweighting to the largest companies and therefore the most successful companies that are growing market capitalization.

You're a genius because you knew it all along about Nvidia. If you have an S&P 500 fund, right?

You hand off the chess piece, your exposure to successful companies just grows. Fixed income markets as cap-weighted indices, grow by who is the largest borrower, right? So your exposure as a passive investor is to the ever greatest debtors in the market. And there in this instance, it's the US Treasury. And so when you think about the broad sort of aggregate index, which is kind of the bond market's version of the S&P 500, your composition of that index is about 94% between treasuries, agency mortgage-backed securities, and investment-grade credit, which is all long duration, and low-spread assets. So it's completely suboptimal and it constantly reweights into ever more treasuries. So active management on the fixed income side today, where you can go into the securitized markets, where you can go into the, you know, off-benchmark parts of credit like high yield globally and find the best opportunities. It's a very different game between equities and fixed income in that regard.

If you're a US investor and you're figuring out what to do with the bond portion of your portfolio, How concerned do you have to be about the value of the dollar and, you know, how that's going to change down the road?

You know, I think there's a lot of hyperbole about the short-term price action. You know, people are saying, gosh, the dollar's super weak today. If you look, if you look at the trade-weighted dollar, the Fed has an index for this. It's higher on a 1, 5, 10, 15, and 20-year basis. So if you want to say, gosh, it was, it was higher in January, Yes, it was, but it's higher today than it was last September when we had a growth scare. And if you look at where the dollar has dipped over the last several years, it's been when we've had these kind of convincing sort of hard landing scares. Remember back to the regional banking crisis in 2023. So, you know, the, the, the dollar is the world's reserve currency. It is so entrenched today. It takes decades to reverse something like that. It's like trying to get a country to change its system of weights and measures. You know, it's very, very arduous to try to change a, you know, an infrastructure and a standard that's like that. If you take intra-European trade away, which of course they're going to trade with one another in euros or invoice in euros, about 75% of trade is invoiced in dollars. The BIS suggests that over 80% of global trade finance is done in dollars, many times with borrowers and lenders, neither one of which is a US entity. And so it's really, really hard to upend that. And then, you know, Jack, if you're talking about depth and breadth of bond markets, nothing compares to the US. If you're talking about shareholder returns and growth stocks, nothing compares to the US. So you can have marginal ebbs and flows one day to the next, but the dollar is the world's reserve currency, is not changing.

Last question I have. You are the bond guy, right? So there, I assume that there's someone at your firm who's the stock person. There's probably another person whose job it is to say, how people ought to be allocated between stocks and bonds and lots of other stuff. So I don't know about asking the bond guy about how good of a deal bonds are relative to stocks, but that's, you know, apart from whether bonds are a good deal on their own, if you look at where stocks are priced and what's happening with the economy and, you know, for the 60/40 investor out there, what do you think about the tilt that, you know, people ought to have? Should there be a shift in their preference right now for bonds versus stocks or the other way around?

So, um, again, I'm not an equity expert, but I'll give you my view since you asked the question. I am very bullish on, uh, the US economy and very bullish on the US stock market. And I think 60/40 works for investors today, uh, very much like it has in the past. But today, fixed income is the income part. I think people are underestimating what's possible with the proliferation of AI. I mean, it's funny, 6 months ago, that's the only thing we could talk about. Today, we're not even talking about it. I don't know about you, but the tools that are on my desk today that I can use to make my job easier and make me better at what I do are profoundly better than they were just 6 months ago. When you deep dive agentic AI, physical AI, and what this means for every corner of the economy, you could come up with some pretty remarkable productivity enhancements over the next 5 years, which would be, you know, very much flattering profit margins. Jack, I have some 20-year-old-ish sons and they're kind of dabbling investing for the first time. And you know, during early May they were like, dad, the market's rallying. We missed, we missed the rally. I'm like, guys, the range on the S&P 500 over the next 10 years is probably 5,000 on the downside and 10,000 on the upside. So you're going to be kicking yourself if you're getting too cute about 100 S&P points now. So I think a portfolio that's comprised of a 6.5 to 7% yielding high-quality, low-volatility fixed income allocation with the S&P 500, and particularly if you can handpick growth stocks, is a really elegant construction.

This is warming my heart to hear. Are you like the most bullish guy in the room when you go to cocktail parties and you're talking with the other strategists out there? This sounds like everybody's cautiously optimistic at best right now, and some sound pessimistic. So you feel like you're on more in the optimistic camp right now?

I very much am. And I do feel like that's an out-of-consensus view today. I haven't always been, I'm a card-carrying member of the wet blanket club. I have been in the past. So, but today I just listen, I call it like I see it. And I think there is definitely uncertainty today. We are in a moment of a stagflationary kind of incremental evolution. Over the next quarter, couple of quarters, the hard data will decelerate a little bit. Inflation will tick up a little bit. But I think, you know, the equity market is a discounting mechanism that's going to look down the road and can look through that. And that kind of slowdown does not dent credit quality in the fixed income market.

Thank you, Russ, and thank all of you for listening. If you have a question you'd like played and answered on the podcast, you can send it in. Could be in a future episode. Just use the voice memo app. You send it to jack.hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. Thanks and see you next week.

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