Bob’s Journal for 7/22/21

Junk Bonds Aren’t ‘High-Yield’ Now

The Federal Reserve’s monetary policy achieved at least one of its goals.

The policy pushed investors out of safer investments into more risky ones in search of higher yields and returns. High-yield bonds typically offer yields well above those of treasury bonds and other safe income investments.

Usually, the excess yield on high-yield bonds is five to seven percentage points above the yield on comparable treasury bonds. In the financial crisis, the spread reached almost 20 percentage points. During the early days of the pandemic in March 2020, yields on junk bonds were more than 10 percentage points higher than treasury yields.

High-yield bonds usually offer excess yields because there is more risk of bankruptcy or default. Issuers of high-yield bonds have lower credit ratings than investment-grade bond issuers.

But much of that extra yield for owning the riskier bonds is gone.

For example, the yield on the iShares iBoxx High Yield Corporate Bond (HYG) exchange-traded fund (ETF) now is only 4.46%. The yield on the iShares iBoxx Investment Grade Corporate Bond (LQD) ETF is 2.41%.

The yield spread is approaching the all-time low reached in May 2007.

The search by income investors for higher yields is one factor. With yields on other income investments around 1% or less, many investors moved from certificates of deposit (CDs) and government bonds to high-yield bonds. The increased demand for high-yield bonds pushed down their yields.

The strength of the economy is another factor. There’s little risk of default, as long as growth is strong, leading investors to accept lower yields.

Another factor is the high-yield bond indexes currently are less risky than usual. The highest credit rating in the high-yield bond category, double-B, now is given to 54% of bonds in the indexes, compared to 47% two years ago and 38% just before the financial crisis, according to The Wall Street Journal.

Investors now have little or no margin of safety in high-yield bonds. Their prices will tumble, and yields will soar as soon as investors sense any trouble in the economy.

Solving the Retirement Decumulation Problem

Some financial advisors say that a number of retirees were very good at accumulating nest eggs during their working lives but are bad at decumulating, or spending, during retirement. They say that many people have trouble shifting gears from saving to spending.

One financial advisor recently dubbed this the “frugality syndrome.” Saving and accumulating during the working years became an end in itself for many people and a practice that’s tough to change.

The Employee Benefit Research Institute (EBRI) recently issued a survey of retirees that confirmed many retirees are unwilling to spend from their nest eggs, even when they believe their assets are more than adequate to fund retirement spending.

Though it might not seem like a problem, unwillingness to spend from the nest egg during retirement has some negative consequences. It can result in a lower standard of living than was earned. Some people deprive themselves of needed medical care or basic comforts to avoid spending money. It also can reduce lifetime gifts to charity and loved ones.

But we need to distinguish excess frugality from a sound long-term plan.

Many retirees don’t want to spend more money because they’re accumulating a legacy for their children. Others are preparing for potential late-in-life medical expenses or long-term care expenses. Many fear that they’ll live a long time and don’t want to drain their resources early in retirement.

Whatever the reasons for the lack of spending, it is clear that most standard retirement plans are wrong, because they assume retirees increase their spending each year by at least the rate of inflation. Most retirees don’t actually spend that way, and they shouldn’t.

The major gap in most retirement plans is the lack of a sustainable spending plan. Few retirees have such a plan.

The plan should allow a retiree to enjoy the standard of living that a lifetime of saving and investing provides and ensure the nest egg lasts for life, no matter how long that turns out to be. The plan should be flexible, so that spending automatically adjusts with inflation and market changes.

You can find details about establishing a sustainable spending plan in past issues of Retirement Watch and the Spotlight Series, as well as in my book, “The New Rules of Retirement.”

Avoid the Long Arm of the State Tax Authorities

You might think you moved to another state. But tax authorities in your old state, especially if it’s a high-tax state, still could tax your income.

In a recent case, a couple lived and owned a home and business in California beginning in 1998. In early 2008, they drove to Nevada and secured an apartment to rent.

They also registered to vote in Nevada and obtained Nevada driver’s licenses. They obtained a cell phone with a Nevada number and opened new bank accounts in Nevada.

Over the next few months, they registered their cars in Nevada, made offers on homes in Nevada and took other steps to establish Nevada as their new residence.

They still owned the home and business in California. A potential buyer of the business contacted them in Nevada in May 2008. They negotiated the sale of the business and closed it in July that year. The documents were executed in Nevada.

The couple filed a California tax return as part-year residents. They said they changed their domicile in February before concluding the sale of the business and did not owe California taxes on the sale.

The California tax authorities disagreed and said the couple were domiciled in California until September 2008, when they purchased a home in Nevada.

The California court said that once a person is a California domicile, he or she remains a California domicile until actually moving to a new residence with the intent to remain there permanently or indefinitely.

At the time of the business sale, the couple hadn’t sold their California home and most of their personal property was still in that home. They also spent a significant number of days in California in early 2008 as they traveled back and forth between California and Nevada.

The court said their domicile in California wasn’t ended until a home was purchased in Nevada. Before that, they hadn’t established the intent to remain there permanently or indefinitely. They owed California taxes on the sale of their business.

In the February 2021 issue of Retirement Watch I explained the importance of proving your state of residence or domicile and gave detailed guidelines on how to do that after moving, so you don’t end up in the same position as the couple in this case.

The Data

New unemployment claims declined 26,000 to 360,000. That’s a new low for the pandemic period. But the previous week’s total of new claims was revised higher to 386,000 from 373,000.

Continuing claims declined by 126,000 to 3.24 million.

The total number of people receiving some form of unemployment benefits declined by about 449,000 to 14.2 million, roughly half the level of 12 months earlier.

The Empire State Manufacturing Index was reported at a record high of 43.0 in July. That compares to 17.4 in June.

But the Philadelphia Fed Manufacturing Index reported that manufacturing in that area was growing at a slower rate. The Index was 21.9 in July, down from 30.7 in June.

Industrial Production increased by 0.4% in June from May’s level. But May’s production increase was revised down to 0.7% from 0.8%.

Consumer demand for goods remains strong. Retail sales increased 0.6% in June. Excluding vehicles and gas, sales rose 1.1% in June. Over 12 months, retail sales soared 18.0% and are higher than before the pandemic.

Sales of motor vehicles were down sharply in June because of supply shortages. But sales of other goods increased, as did spending at restaurants and bars. Higher prices were part of the reason for the retail sales increase.

But May’s sales were revised sharply lower. The initially reported increase of 1.7% was revised to a decline of 1.3%.

The only services in the retail sales report are sales at restaurants and bars. Most of the report covers sales of goods.

Consumer Sentiment, as reported by the University of Michigan, declined to 80.8 in mid-July from 85.5 at the end of June. Concerns about inflation were a major cause of the decline.

Optimism among home builders declined a little again in July. The Housing Market Index from NAHB fell to 80, down from 81 in June. The index was 83 in both April and May.

Home builders remain concerned that shortages of labor and materials are reducing the inventory of new homes and causing price increases that take some buyers out of the market.

Housing starts increased 6.3% in June from May’s level and rose 29.1% over 12 months. But the number of starts reported for April and May was revised down.

The 12-month change is likely to be much lower next month when the July numbers are reported, because the stall in home starts that occurred early in the pandemic had ended by July 2020.

Building permits declined 5.1% in June. The decline in permits reflects supply problems and higher prices causing potential buyers to exit the market.

The Markets

The S&P 500 lost 1.04% for the week ended with Tuesday’s close. The Dow Jones Industrial Average declined 1.06%. The Russell 2000 fell 1.80%. The All-Country World Index (excluding U.S. stocks) tumbled 2.29%. Emerging market equities retreated 1.47%.

Long-term treasuries rose 3.29% for the week. Investment-grade bonds increased 1.23%. Treasury Inflation-Protected Securities (TIPS) added 0.59%. High-yield bonds lost 0.22%.

As for currencies, the U.S. dollar rose 0.22%.

Energy-based commodities lost 4.08%. Broader-based commodities fell 1.58%. Gold gained 0.06%.

Bob’s News & Updates

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” It tells you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.

A recent five-star review of my book on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

If you’re interested in my books, check my Amazon.com author’s page.

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