We’ve all experienced the effects of inflation in one way or another, and whether you are financially savvy or not, it is fairly common knowledge by now that inflation is impacting investments. In this article, we are going to focus on corporate bonds. Is now a good time to be investing in corporate bonds? Great question.
Over the last couple of years, the inflation rate has been rising above the interest rate earned on bonds — making bonds a fairly unattractive asset class to own. For example, let’s say inflation is 5% and interest rates are 3%. In that case, your return adjusted for inflation is almost guaranteed to be no better than -2% per annum. In early 2021, we wrote a long article recommending against owning a large investment allocation to bonds.
In retrospect that turned out to be the right call. Inflation accelerated in 2021 and 2022, and interest rates have risen significantly, causing a steep drop in bond prices, including corporate bond prices. According to Reuters, rapid inflation raises concerns about the ability of corporations to generate revenue and repay their debts, which would have a trickle-down effect on the economy as a whole.
This raises the question: Is now a good time to invest in corporate bonds?
What is the short-term and long-term outlook of corporate bonds?
Because we believe a recession is on the horizon, likely in 2023, the short-term outlook for this asset is not looking good. Corporate bond spreads and credit defaults could increase significantly, causing corporate bond prices to decline further. This happened during the financial crisis in 2008 and again during the pandemic in March 2020; it could certainly happen again.
On the other hand, interest rates are a lot more attractive now, and if you buy highly rated, investment grade corporate bonds, it’s possible to generate returns until the maturity of the bond of 5% or more. It might be a nice, safe way to make 5%, and it certainly seems more attractive at the present moment (November 2022) than owning stocks.
What is the best option among corporate bonds?
Because of the threat of recession, aim to invest in high-quality credits and in bond issues that have a relatively short duration (i.e., two to three years). You also might want to diversify into short-term treasuries, which you can easily sell to buy corporate bonds at a discount should the opportunity arise during a recession.
Find the best investments for inflation
Bonds are a necessary part of any diversified portfolio, but we think your allocation to bonds should be continuously reexamined in light of current market conditions, prevailing interest rates, and the economic outlook. When hedging against inflation, there are better asset classes to own, but it all depends on how personally averse to inflation risk you are and what your portfolio goals are.
Check out the information on our website to learn more about specific financial assets or contact one of our financial experts today for a more detailed analysis of your personal financial situation.
This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy,” dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment, or other professional advice. The views expressed are those of the author(s) as of the date of publication of this article and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future.