2012 was another good year for the bond markets as the
investors continued to pour money into bond funds even though the
yields plunged. The benchmark 10-year note ended the year at
since 1962 and five-year note yield ended at 0.73%--their
lowest year-end closing level since 1986.
However as the two parties managed to arrive at a last-minute
compromise to avoid the cliff, bond yield soared while the stocks
rallied. The investors have put
more than $18 billion
in stock funds during the first week of this year-largest inflow
since June 2008, when the recession began.
As a result, 10-year note's yield rose to 1.97% earlier this
month--its highest level since April but has since moved down to
1.87% as of this morning. (Read:
3 Great ETFs for the Earnings Season
The minutes of the last FOMC meeting of 2012 released earlier
this month further supported the trend as many investors worried
that the Fed may end its QE program in 2013. Fed's massive
purchases have been the main factor in keeping the yields at
dangerously low levels. Per FOMC minutes "several members now
think that it would probably be appropriate to slow or stop
purchases well before the end of 2013".
In all, Fed currently buys about $85 billion of longer-term
bonds each month. Further they have pledged to keep the target
range for the fed funds rate between 0% and 0.25%-- as long as
the unemployment rate remains above 6.5% and medium-term
inflation does not exceed 2.5%. Overall the Fed may purchase
about $1 trillion in bonds this year.
Fed's balance sheet has exploded since 2008 but despite
significant monetary expansion, inflation has remained benign so
far. Bernanke has often said that the aim of the Fed policy is to
push the investors to take more risk. On the other hand, may
economists have expressed apprehension that large scale asset
purchases by the Fed are disrupting market dynamics.
During a speech earlier this week the Fed Chairman downplayed
the fears of inflation and reiterated that the economy was still
in a "relatively fragile recovery".
Rates will have to go up eventually but that doesn't appear to
the case anytime soon. Many market gurus have proclaimed
deflation of the bond bubble in the last few years but that did
The idea about the bear market in bonds being finally on the
horizon based on one week of fund slows appears to be rather
premature. Further it is difficult to predict a market that is
driven by the Fed and not by fundamentals. (Read:
4 Best ETF Srategies for 2013
Also, in the short-term, the movement in yields may follow the
developments on the debt ceiling debate. If the negotiations turn
nasty, the investors may seek refuge in treasuries again as they
did when the lawmakers failed to arrive at an agreement to raise
the debt ceiling in 2011 till the eleventh hour. Further if
economic growth continues to be lackluster or stalls, the yields
may stay low.
While a massive sell-off in the bonds is not likely anytime
soon, it is quite possible that the rates may finally start to
move up later this year, ending the 30 year down-trend in yields.
And as the yields are currently very low, the losses will be very
high if the yields go up. So, it may finally be the time when the
treasury bond ETF investors should start looking at much better
options available to them.
At current valuations, stocks look much more attractive than
bonds and will deliver much better returns in the longer-term.
Most large US blue chips are sitting on piles of cash and are in
a position to increase dividends. Average dividend yield of
S&P 500 companies is currently 2.12%. We recommend Vanguard
Dividend Appreciation ETF (
) which holds stocks of high quality companies that have a
record of increasing dividends for at least 10 years. It is Zacks
rank 1-'Strong Buy' ETF.
Emerging market sovereign bonds still look attractive even
though the spread has tightened in the last couple of years. Many
of the emerging countries have better fiscal health than
developed countries and further they still have scope to cut
rates, whereas interest rates in developed countries are already
at historic low levels. Investors should look at J.P. Morgan USD
Emerging Markets Bond Fund (
) or PowerShares Emerging Markets Sovereign Debt Portfolio (
) which yield around 5% currently (Read: E
merging Markets Sovereign Bond ETFs-Safe with
The investors wanting some exposure to US treasury bonds in
their fixed income portfolios may consider shorter-end of the
curve as the yield curve may continue to steepen this year.
Renowned bond guru Bill Gross recommends buying 5-year treasuries
and predicts their yield to come down to 0.7% this year. iShares
Barclays 3-7 Year Treasury Bond (
) charges an expense ratio of 0.15% only but yields 0.87%
Investors betting on bond market collapse using inverse
like ProShares UltraShort 20+ Year ETF (
) or ProShares Short 20+ Year Treasury ETF (
) need to keep in mind that these ETFs are meant for short-term
trading or hedging purpose only. Many of them are designed to
achieve their stated performance goal on a daily basis. Over a
period longer than one day their performance can differ
significantly from their stated daily performance objectives.
Further the expense ratios of these ETFs are on the higher side.
Leveraged and Inverse ETFs--Suitable Only For
Short Term Trading
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