{"id":9475,"date":"2023-05-26T16:58:15","date_gmt":"2023-05-26T16:58:15","guid":{"rendered":"https:\/\/zacksim.com\/financial-professionals-insights\/?p=9475"},"modified":"2023-05-26T16:58:15","modified_gmt":"2023-05-26T16:58:15","slug":"debt-ceiling-standoff-pushing-misguided-flight-to-safety","status":"publish","type":"post","link":"https:\/\/zacksim.com\/financial-professionals-insights\/debt-ceiling-standoff-pushing-misguided-flight-to-safety\/","title":{"rendered":"Debt Ceiling Standoff Pushing Misguided ‘Flight to Safety’"},"content":{"rendered":"\n

Regional bank stress in March, followed by the debt ceiling standoff over the past several weeks, has led some investors to recalibrate risk in the capital markets. The question is whether this recalibration is wise and informed, or whether it\u2019s a misguided response driven by worry and recency bias.1<\/sup><\/p>\n\n\n\n

I\u2019ll make my case for the latter.  <\/p>\n\n\n\n

One area where we\u2019re seeing an unusual trend is in the spreads between some investment-grade corporate bonds and short-duration U.S. Treasurys. Normally, investors peg Treasury yields as the risk-free rate, which can be used as a minimum starting point for expected returns from other types of investments, whether they be other bonds, stocks, real estate, etc. Since every security is technically riskier than U.S. Treasurys \u2013 given Treasurys’ status as the world\u2019s safest investment \u2013 one would expect investors to demand a higher return from other types of securities.2<\/sup><\/p>\n\n\n\n

But that\u2019s not the case right now for some investment-grade corporate bonds.   <\/p>\n\n\n\n

Indeed, in a rare occurrence, we\u2019re seeing some investment-grade corporate bonds trading at a yield discount <\/em>to U.S. Treasuries. Two distinct examples are Microsoft bonds coming due in early August, along with Johnson & Johnson bonds that come due in November. The Microsoft bonds in recent days have been trading at yields slightly higher than 4%, which compares to the slightly higher than 5% yield on Treasurys coming due around the same time. The Johnson & Johnson bonds trade at a similar discount.<\/p>\n\n\n\n

The unusual spread is largely driven by the debt ceiling standoff. There is fear that failing to reach an agreement on the debt ceiling would first affect the Treasury bonds coming due this summer, i.e., that these would be the first payments missed by the U.S. government. While this explains the elevated yields, I\u2019m not sure it justifies labeling Microsoft corporate bonds as safer than U.S. Treasurys at this moment. I\u2019ve made the argument before that the U.S. government can likely prioritize bond payments over other obligations, and also that the U.S. Treasury has adequate tax revenues to avoid default. The market\u2019s treatment of some investment-grade corporate bonds relative to Treasurys looks like a short-term mispricing, in my view.<\/p>\n\n\n\n

Another flight to \u2018safety\u2019 trend we\u2019re seeing is in current investor sentiment for gold versus stocks. In a recent Gallup poll, 26% of Americans ranked gold as the best long-term<\/em> investment in 2023, up from 15% in 2022. Stocks moved in the opposite direction year-over-year: in early 2022, 24% of Americans saw stocks as the best long-term investment. In 2023, the figure had dropped to 18%.<\/p>\n\n\n\n

What happened in the last year? For one, stocks and bonds delivered negative returns in 2022, which I think contributes heavily to investors experiencing \u2018recency bias.\u2019 The assumption becomes that since stocks did poorly last year, they are likely to do poorly again this year. But we know from history that\u2019s rarely the case.<\/p>\n\n\n\n

The second thing to happen was the regional bank stress and currently, the debt ceiling standoff. To be fair, gold prices do tend to jump in the wake of major shocks or events. In the early days of the pandemic and Russia\u2019s invasion of Ukraine, for instance, gold prices rose. Investors may be viewing bank stress and the debt ceiling as the next iterations of the \u2018crises\u2019 of the U.S. economy, which I think will turn out to be wrong.<\/p>\n\n\n\n

History suggests that favoring gold as a long-term investment is not a good mindset. From 1970 to 2022, the S&P 500 has delivered an average annual return of 10.43%. Over the same period, gold returned 7.7%. The reason I use 1970 is because that was the year the gold standard ended, meaning the price of gold was subject to market forces. The 3% difference in annualized returns over 50 years is very significant.<\/p>\n\n\n\n

Bottom Line for Investors<\/strong><\/p>\n\n\n\n

Viewing investment grade corporate bonds as safer than Treasurys\u2014or viewing gold as a better long-term investment than stocks\u2014seems more of a byproduct of fear and recency bias than it is grounded in fundamentals. Case in point: if we look beyond this summer and fall to Treasurys that mature beyond 2023, we see that they\u2019re trading at yields below AAA corporate bonds. Investors may be stuck thinking too short-term.<\/p>\n\n\n\n

My base case assumption is that the U.S. government will reach a debt ceiling agreement and that no payments on U.S. Treasury bonds will be missed, as we\u2019ve seen in many previous instances of this issue. I also think the regional bank stress is fading and that the effects on the U.S. banking system won\u2019t be severe, or permanent. In other words, there\u2019s no reason to make knee-jerk allocation decisions based on the perceived risks of the moment.<\/p>\n","protected":false},"excerpt":{"rendered":"

Regional bank stress and the debt ceiling fight are prompting investor fears, and a misguided recalibration of risk<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[181,1],"tags":[],"class_list":["post-9475","post","type-post","status-publish","format-standard","hentry","category-financial-professionals","category-mitch-on-the-markets"],"acf":[],"_links":{"self":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9475","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/comments?post=9475"}],"version-history":[{"count":2,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9475\/revisions"}],"predecessor-version":[{"id":9477,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9475\/revisions\/9477"}],"wp:attachment":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/media?parent=9475"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/categories?post=9475"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/tags?post=9475"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}