Happy Returns?
2023 was a much better year for income investors than 2022 was across various types of assets. How will they fare in 2024?
2023 turned out to be a solid year across many income investing categories, especially compared to the previous year’s dismal results.
Last year was particularly strong in income-oriented asset classes such as junk bonds and preferred stocks. The SPDR® Bloomberg High Yield Bond ETF (JNK) returned 12.4%, reversing a 12.2% loss in 2022. The iShares Preferred & Income Securities ETF (PFF) returned 9.2%, compared with an 18% loss the previous year.
Preferred securities are mostly issued by banks, which held up last year despite the Silicon Valley Banking Crisis that spurred worries about liquidity. Banks stocks, however, didn’t get much love, with the Invesco KBW Regional Banking ETF (KBWR) off by about 1% in 2023.
Elsewhere, junk bonds would come under pressure if the economy started to slip, but that did not happen last year – even though there were plenty of predictions to the contrary. The economy’s durability helped junk bonds, which are below investment grade. That asset class held up well last year, however.
Overall fixed-income performance improved, as well. The iShares Core US Aggregate Bond ETF (AGG), a proxy for the investment-grade bond market, returned 5.7%, including interest payments -- a big turnaround from the previous year’s minus 13% result.
Even though dividend stocks made decent gains last year, they lagged the broader market, which was driven by large-cap names, in particular the Magnificent Seven. Those seven stocks, which include Tesla (TSLA), Amazon.com (AMZN) and Meta Platforms (META), all gained more than 48% last year – and in some cases a lot more. Nvidia (NVDA), which has benefitted from its chips that support artificial intelligence, skyrocketed by more than 200%.
But these seven stocks haven’t helped income investors all that much. Most of the Magnificent Seven, which led the stock market for much of last year, don’t even pay dividends, let alone big ones. And the ones that do, notably Apple (APPL) and Microsoft (MSFT), sport low yields.
The ProShares S&P 500 Dividend Aristocrats (ticker:NOBL) returned 8.1% last year, including dividends. But the SPDR S&P 500 ETF Trust (SPY) returned 26.2%. The constituents of the Aristocrats index, which include Johnson & Johnson (JNJ), Exxon Mobil (XOM) and 3M (MMM), have paid out a higher dividend for at least 25 straight years.
Data as of Jan. 23.
Still, there were some silver linings for income investors – one being that attractive yields have finally returned to the bond market after roughly a decade of ultra-low interest rates thanks to the Federal Reserve’s policies.
The 10-year U.S. Treasury Note was recently yielding 4.09%, down from 5% in last year’s fourth quarter. That yield has bounced around quite a bit owing to changing expectations about Fed Policy and the strength and growth of the U.S. economy. But in early 2022, before the Fed started to boost short-term rates, the 10-year Treasury was yielding below 2%.
“There is a source of safer yield in this world,” Michael Santoli, senior markets commentator at CNBC, told Income Matters Today recently. “That’s a switch from the last 10 or 12 years [but] I think that people have had to adapt to that idea.”
“What it means is that fixed income can again start to perform its role in a portfolio,” he adds.
That includes providing diversification to stocks, a relationship that broke down in 2022 as both asset classes struggled.
It’s important to remember, however, that many bond investors are looking for the income component – and not always the capital appreciation component. In 2022, however, many of their bond holdings suffered big losses as rates shot up.
Bond prices and yields move inversely. So even though yields were much higher as that year went on, their fixed-income statements showed losses.
But in 2023, there was plenty of respectable performance.
iShares National Muni Bond ETF (MUB) was up 5.6%, including interest payments, reversing a 7.5% loss in 2022. Munis offer an advantage: the coupon payments are exempt from federal taxes and, in some cases, from state and local levies as well. Their effective yields are higher than their stated yields, making them an attractive income alternative to investors in higher tax brackets.
The iShares 20+Year Treasury Bond ETF (TLT), which took a big hit in 2022, returned a respectable 2.8% last year. The longer end of the yield curve, in particular, took a beating as interest rates climbed.
The shorter end of the Treasury curve acquitted itself well, too.
The iShares 1-3 Year Treasury Bond ETF (SHY) was up 4.2% last year, versus a loss of nearly 4% in 2022.
Even Treasury Inflation Protected Securities, or TIPS, rebounded after a very disappointing 2022.
The iShares TIPS Bond ETF (TIP) was up 3.8%, a much better result than its 12.2% loss in 2022. The irony was that in one of the worst inflation stretches in memory, TIPs didn’t provide much protection as their prices were overwhelmed by sharply rising bond yields. That situation looks a lot better, though, as 2024 gets rolling.
What will 2024 bring for income investors?
So far things have been flattish in different asset classes. The Dividend Aristocrats ETF was off about 1% year to date as of Jan. 23, trailing the broader stock market’s return of 2%, including dividends.
Still, stocks of that ilk –large, established companies with long histories of dividend growth – deserve strong consideration in any investing climate.
The stocks that make up the S&P 500 Dividend Aristocrats Index “end up being a quality portfolio,” Santoli observed recently, adding that it serves as “a quality plus yield filter.”
The ETF tracking the AGG ETF is off by about 1%. Junk bonds are down slightly so far this year, as are municipal issues and TIPs.
No doubt, if the Fed starts to cut short-term rates, it should help bond prices. But it’s unclear as to when that will occur.
In the meantime, rising bond yields at the long end of the curve have hurt bond prices in that part of the market.
The iShares 20+ Year Treasury Bond ETF, for example, was down by about 5% this year through Jan. 23.
Last year was a welcome change for many income investing categories after a very bad stretch. We’ll have more on how 2024 is shaping up in the coming weeks.
Note: The return data for this article is from Morningstar.
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