Wells Fargo says investors need to prioritize income. Where it sees opportunity
In this uncertain world, investors should prioritize income in their portfolios, according to Wells Fargo Investment Institute. Interest rates are expected to remain higher for longer as inflation this year shows signs of picking up. The Federal Reserve held rates steady at the conclusion of its June meeting Wednesday and the market isn’t anticipating any further cuts this year. Investors have to balance that backdrop with potential risks ahead, Darrell Cronk, president of Wells Fargo Investment Institute and chief investment officer for Wealth and Investment Management, said in the bank’s midyear outlook. Prioritizing income is one of several investment ideas he laid out for the rest of the year. “Although investors are now able to lock in higher yields than we’ve seen in decades, today’s economic backdrop brings key risks that include inflation, income replacement (i.e., replacing maturing bonds with new assets paying similar interest rates), and stock market concentration with high-level uncertainty as markets digest the effects of the U.S.-Iran war and accompanying high oil prices, a new Fed chairman, and an upcoming mid-year election that may have impacts on fiscal policy, both before and after the election,” Cronk wrote. Various assets Therefore, income should come from a variety of assets, Cronk and his team believe. “Building an income-focused portfolio isn’t just about building a laddered bond portfolio anymore. It’s about building a resilient, multi-asset class income stream,” Tracie McMillion, head of global asset allocation strategy, said after the outlook’s release. That means adding dividend stocks, which can grow when prices rise, unlike traditional fixed income assets, which don’t typically hedge inflation risk, she said. Specifically, she prefers sectors such as financials, industrials and utilities, which tend to benefit from inflation and as a group also pay above-market dividends. Dividend stocks can also help investors diversify away from a heavy concentration in technology companies, McMillion noted. “While higher dividend paying stocks may not always be the fastest growing names, they may be more resilient as technology-related equities enter periods of selling, as we have seen repeatedly since at least last October,” the outlook said. NOBL YTD mountain ProShares S & P 500 Dividend Aristocrats ETF year to date Select bonds Within fixed income, Wells Fargo prefers the intermediate part of the curve — with maturities from three to seven years — which offers attractive income without taking on the full interest rate risk of long-term bonds. Quality also matters in the credit market because dispersion is increasing, the outlook said. Focusing on high-quality assets can help not only provide income, but stability and diversification as well — particularly important when markets are adjusting to higher interest rates and greater geopolitical uncertainty, the report said. Wells Fargo favors investment grade corporate bonds and specifically likes more defensive sectors such as telecommunications and utilities. “Corporate fundamentals, as we know, remain solid, supported by earnings growth and resilient balance sheets, and at the same time, yields today are very much attractive relative to the past two decades, even with the tightening of spreads,” said Luis Alvarado, co-head of global fixed income at Wells Fargo Investment Institute. Tight credit spreads mean investors are generally getting less compensation for taking on credit risk Within securitized credit, mortgage-backed securities and asset-backed securities stand out due to their attractive income and shorter durations, Alvarado said. MBB YTD mountain iShares MBS ETF year to date Wells Fargo also finds municipal bonds attractive right now for their tax-efficient income and strong fundamentals. The income on munis is not subject to federal taxes and is also free of state taxation, if the bondholder lives in the state in which the bond is issued. The team prefers local general obligation and essential revenue services bonds. “Within sectors, select transportation credits, notably toll roads and airports, continue to stand out as relative bright spots while parts of higher education and healthcare face growing headwinds from funding pressure, rising costs and weakening demand trends,” the outlook said. Investors should also consider taking advantage of market pullbacks and allocate some capital to emerging market bonds, which offer higher yields than in the United States or other developed markets, Alvarado pointed out. Lastly, while high-yield bonds are not considered high quality, Wells Fargo suggests having some exposure to them as a portfolio diversifier. BB-rated issuers have strong businesses that operate with higher leverage than investment-grade companies, but they maintain profitability and liquidity that can support valuations, Wells Fargo believes.
