FMD Capital Management

Bond Bulls Are Back In Control

Written by David Fabian, October 22nd, 2013

The reports of my death have been greatly exaggerated. – Mark Twain

It wasn’t more than six weeks ago when economists and market forecasters were bemoaning rising interest rates and categorically shunning bonds of all shapes and sizes.  Investors were shaken with the fear that the “great rotation” out of bonds and into stocks was finally starting to materialize after a nearly 30-year bull market in fixed-income.

From May through September of this year we saw the 10-year Treasury Yield spike from a low of 1.65% to a high of 3.00%.  That is easily the biggest move we have seen in interest rates since the mid-1990’s and sent investors fleeing from their beloved fixed-income ETFs and mutual funds.  Long-duration treasuries were the hardest hit during this time frame, as the iShares 20+ Year Treasury Bond ETF (TLT) fell more than 17% from high to low. 

However, the Federal Reserve opted not to taper its asset purchase programs during its September meeting, which sent interest rate sensitive securities soaring.  Since that announcement, we have seen a modest rally in fixed-income that is looking like it might continue through the balance of the year.

Today’s job’s report solidified the notion that the economy is not adding a stellar number of new positions and most Fed watchers agree that this will push a taper decision to 2014.  Labor metrics are one of the key indicators that the Fed is using to determine their exit strategy from the $85 billion per month of treasury and mortgage bond stimulus.

The forecast for continued quantitative easing in addition to a weak job market has combined to push several of the largest fixed-income ETFs on my watch list back above their 200-day moving averages today.

iShares Aggregate Bond Fund (AGG)

iShares Investment Grade Bond Fund (LQD)

PIMCO Total Return Fund (BOND)

Vanguard Total Bond Market (BND)

iShares MBS Bond ETF (MBB)

A push back above this technical level for these core holdings likely means that fears of rising interest rates have been at least temporarily calmed.  In addition, investors are taking advantage of higher yields and more attractive valuations than we saw earlier in the year.  Lastly, it could also be a sign of a move to add defensive positions to investors’ portfolios in an effort to balance out highly appreciated stock positions.  A correction in the stock market would likely trigger a flight to quality from equities to bonds that would lift fixed-income prices even higher.

How to Play Bonds In Your Portfolio Moving Forward

If you have been a stalwart holder of your bond allocation, I would continue to ride this rally and use the momentum to sell any underperforming positions.  Eventually we are going to see a return of fear over the Fed’s monetary policy that will once again shake the bond market.  I would look to rotate into shorter duration securities that still offer competitive yields and will help insulate your portfolio from additional interest rate volatility.

In addition, one of the areas that I see the most value for fixed-income investors right now is through actively managed closed-end funds that offer higher yields and unique strategies that you can’t obtain in an ETF.  Many closed-end funds benefit from being able to shift their allocation to areas of the market that are offering the most attractive opportunities without having to worry about tracking a specific index.

No matter how you adjust your fixed-income exposure over the next several weeks, remember to keep a balanced mindset that takes into account the potential for an extension of this rally.  In addition, you should be actively sizing your positions to your risk tolerance, income requirements, and portfolio objectives.

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