Rebalancing Towards Bonds for September 2024: Key ETFs to Watch

Economic and Market Conditions

Interest Rate Cuts

One of the most significant factors driving the attractiveness of bonds is the anticipated interest rate cuts by the Federal Reserve. Markets are currently pricing in a 73% likelihood of four or more Fed rate cuts by the end of 2024. This shift in monetary policy is expected to lower funding costs for businesses, making bonds more appealing. The Federal Reserve’s commentary has also indicated a high probability of a 50 basis points (bp) cut in September, with market-implied probabilities increasing to 65%.

Market Volatility and Economic Indicators

The stock market has shown signs of volatility, with the S&P 500 experiencing a 1.7% decline on September 6, 2024, capping a week of four straight declines. Additionally, the nonfarm payrolls report for August showed a rise of only 142,000, missing estimates and raising concerns about growth sustainability. These indicators suggest potential instability in equities, making bonds a more stable investment option.

Historical Correlations and Diversification Benefits

Historically, stock/bond correlations tend to be lower during periods when the Fed shifts towards easing. This suggests that bonds could remain effective in mitigating stock market risk as the Fed moves to lower interest rates. Bonds have also proven to be effective diversifiers during stock market volatility. For instance, when the S&P 500 fell by 7% between July 16 and August 5, 2024, the Bloomberg U.S. Aggregate Bond Index rose by 2%, and long-duration Treasuries gained 5.5%.

Performance of Bonds in Volatility

Bonds as a Safety Net

As stocks climbed over the summer, bonds provided a safety net during a significant stock market dip. This reinforces the notion that bonds may continue to act as a stabilizing force in portfolios. The bond market outlook appears positive, with a notable increase in investment-grade bond sales. This week saw one of the largest volumes on record, with over 50 firms participating, including major issuers like Target, Ford, and Barclays.

Potential for Income Generation

As interest rates are expected to decline, investors will need to adjust income portfolios. Bonds could help lock in quality yields, especially intermediate bonds, as Treasury yields fall. The current bond market outlook indicates a more favorable environment for bond investors compared to previous years. As of midyear 2024, bond yields have significantly increased, with the 2-year Treasury yield at 4.71% and the 10-year Treasury yield at 4.36%, up from 0.25% and 1.45%, respectively, in midyear 2021.

Best Bond ETFs for Investors Now

Short-Term Bond ETFs

Short-term bond ETFs are particularly suitable for investors looking for lower risk and decent yields. Some of the best short-term bond ETFs for September 2024 include:

1. SPDR Portfolio Short-Term Corporate Bond ETF (SPSB)
   • SEC Yield: 4.66%
   • Expense Ratio: 0.04%
   • Assets Under Management (AUM): $7.7 billion
2. iShares 1-5 Year Investment Grade Corporate Bond ETF (IGSB)
   • SEC Yield: 4.67%
   • Expense Ratio: 0.04%
   • AUM: $20.9 billion
3. Schwab 1-5 Year Corporate Bond ETF (SCHJ)
   • SEC Yield: 4.67%
   • Expense Ratio: 0.03%
   • AUM: $446.0 million
4. Vanguard Short-Term Bond ETF (BSV)
   • SEC Yield: 4.12%
   • Expense Ratio: 0.04%
   • AUM: $33.4 billion
5. Fidelity Short-Term Bond Fund (FSHBX)
   • SEC Yield: 4.73%
   • Expense Ratio: 0.30%
   • AUM: $2.3 billion

Long-Term Bond ETFs

For investors looking to benefit from potential rate cuts, long-term bond ETFs are an attractive option. The best long-term bond ETF for 2024 is the Vanguard Long-Term Bond ETF (BLV), priced at approximately $75.32 as of September 6, 2024. It features an exceptionally low annual expense ratio of 0.04%, significantly lower than the average for similar funds.

High-Yield Bond ETFs

High-yield bonds currently offer an average yield of about 7.7% as of June 30, 2024, which is higher than the S&P 500’s long-term average return of 7.4% since 2000. With anticipated rate cuts on the horizon, locking in high yields before they potentially fall could be beneficial for investors. The average credit quality of high-yield bonds has also improved, with approximately 46% of the Bloomberg US Corporate High Yield Index rated BB, up from 34% in 2000.

Risk Management and Diversification

Diversification Strategy

The need for diversification and the potential for higher correlations between stocks and bonds may enhance the need for bond exposure in portfolios. The recommendation emphasizes maintaining a diversified portfolio. As the economic landscape evolves, adjusting allocations to include more bonds could help mitigate risks associated with equities.

Risk Management

The bond market continues to exhibit an inverted yield curve, with short-term Treasury bills yielding higher (5.31% for 3-month bills and 4.06% for 2-year Treasuries) compared to the 10-year Treasury yield at 3.86%. This inversion has persisted since late 2022. Given this environment, investors may consider adjusting their fixed-income strategies, possibly scaling back bond positions due to inflation risks while still recognizing opportunities in the bond market.

Conclusion

In summary, the combination of weak labor market data, expectations of interest rate cuts, and the stable outlook for fixed income suggests that reallocating towards bonds could be prudent in September 2024. The changing interest rate environment and the historical performance of bonds during periods of stock market stress make them a compelling option for rebalancing portfolios. Investors should consider short-term, long-term, and high-yield bond ETFs to diversify their portfolios and mitigate risks associated with equities. By doing so, they can take advantage of the current favorable conditions in the bond market and secure stable income and capital preservation.