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Israel/Iran conflict drives volatility. Market volatility increased following Israel’s airstrike on Iranian nuclear facilities, Iran’s drone attack response and threats of further action from both sides. Oil prices are likely to remain elevated, potentially leading to inflationary pressure. At this point we continue to suggest a balanced portfolio.
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Tariff impact on inflation still looks limited — for now. Last week’s release of the Consumer Price Index (CPI) for May showed further moderation, with both headline and core (ex-food and energy) CPI coming in cooler than expected for the month and compared to a year ago. Meanwhile, shelter inflation, one of the stickiest components of inflation in recent years, ticked down last month, and rent costs increased at their slowest pace in more than four years (Figure 1). The Producer Price Index (PPI), which measures wholesale price changes before they filter through to consumers, ticked up slightly year-overyear in May, to 2.6% from 2.5% in April. We doubt May’s CPI and PPI results will alter the expected policy timeline for the U.S. Federal Reserve, and we continue to expect two rate cuts by year-end.
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Improving sentiment indexes belie caution flags. The percentage of individual investors reporting a bullish perspective rose to near its long-term average of 37.5% in the latest AAII Investor Sentiment Survey (11 June), while the bearish percentage fell to 33.6%, from 41.4% the prior week. Similarly, the National Federation of Independent Business (NFIB) optimism index climbed three points in May to 98.8, the first increase since December. And the University of Michigan Consumer Sentiment Index moved higher for the first time in six months, according to the preliminary June reading.
Despite last week’s announcement of an agreed-upon framework for a U.S./China trade deal, the U.S. tariff rate on imported Chinese goods stands at a hefty 55%. And President Trump said he plans to notify trading partners of new (higher) tariff rates ahead of a self-declared 9 July deadline. Meanwhile, the legal status of Liberation Day tariffs is far from settled, with the levies remaining in place pending a federal appeals court ruling, in August at the earliest. On the employment front, initial jobless claims stayed elevated at 248,000, matching the prior week’s total. Continuing claims jumped to 1.956 million, the highest level since November 2021.
The current lack of clarity leads us to favor portfolio allocations to select credit sectors such as preferred securities, which may offer higher yields and a lower risk profile compared to common stocks.
The mixed macro outlook leads us to favor portfolio allocations with higher yields and attractive risk profiles.
Preferreds could be an attractive choice for diversifying portfolios.
Portfolio considerations
With spreads recovering from April’s widening, preferred securities were among the top-performing credit sectors in May. Total returns for the month were led by our favored segment, $1000 par preferreds (+1.87%), followed closely by contingent capital securities (CoCos, +1.85%), with $25 par preferreds lagging (-0.05%). Despite the rally, preferred spreads remain above historical lows. This, combined with continued robust fundamentals and a supportive technical backdrop, could make preferreds an attractive choice for diversifying portfolios in an unsettled macro environment.
Preferreds are issued primarily by banks, which have generally beaten earnings expectations in recent quarters and consistently passed the Fed’s annual stress tests, which gauge capital strength. Most issuers are investment grade at the senior level, and most preferreds are BBB rated at the security level.
In addition to high quality, preferreds may also offer tax efficiency. Some pay qualified dividend income (QDI), which is taxed at 20% rather than at higher ordinary income tax rates. Moreover, preferreds’ higher yields may provide a total return buffer against an unexpected increase in interest rates. Core bonds, for example, are yielding 4.8% with a duration of 6.1 years, while $1000 par preferreds and CoCos provide a taxable-equivalent yield of 7.3% with a duration of under four years (Figure 2). For incomeseeking investors, these advantages could potentially mean an allocation that’s more defensive than leveraged finance credit sectors, helping sustain a positive demand dynamic for preferreds.
Those looking into preferred securities can consider $1000 par preferreds and CoCos relative to $25 par securities, as the former two segments look more compelling on a risk-adjusted basis and offer better liquidity. Despite its higher yield, the $25 par category offers a less meaningful tax advantage (percentage of income that is QDI). Lastly, we emphasize active management for preferred securities, assessing the opportunity across all three segments and adjusting allocations as necessary.
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
- macro and asset class views that gain consensus among our investors
- insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
- guidance on how to turn our insights into action via regular commentary and communications
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Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Credit risk refers to an issuer’s ability to make interest payments when due. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards.
Investing in preferred securities entails certain risks, including preferred security risk, interest rate risk, income risk, credit risk, non-U.S. securities risk and concentration/ nondiversification risk, among others.
There are special risks associated with investing in preferred securities, including generally an absence of voting rights with respect to the issuing company unless certain events occur. Also in certain circumstances, an issuer of preferred securities may redeem the securities prior to a specified date. As with call provisions, a redemption by the issuer may negatively impact the return of the security held by an account. In addition, preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure and therefore will be subject to greater credit risk than those debt instruments. Credit risk is the risk that an issuer of a security will be unable to make dividend, interest and principal payments when due. Interest rate risk is the risk that interest rates will rise, causing fixed income securities prices to fall. Income risk is the risk that the income will decline because of falling market interest rates. This can result when an account invests the proceeds from new share sales, or from matured or called fixed income securities, at market interest rates that are below the account’s current earnings rate. An investment in foreign securities entails risks such as adverse economic, political, currency, social or regulatory developments in a country including government seizure of assets, lack of liquidity and differing legal or accounting standards (non-U.S. securities risk). Preferred security investments are generally invested in a high percentage of the securities of companies principally engaged in the financial services sector, which makes these investments more susceptible to adverse economic or regulatory occurrences affecting that sector concentration/ nondiversification risk). It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager. Contingent capital securities, sometimes called contingent convertibles (CoCos), are high-yield, high-risk debt instruments primarily issued by European financial institutions. These securities work in a fashion similar to traditional convertible bonds. They have a specific strike price that, once breached, allows the conversion of the bond into equity or stock. Certain types of preferred, hybrid or debt securities with special loss absorption provisions, may be or become so subordinated that they present risks equivalent to, or in some cases even greater than, the same company’s common stock.
This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
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