The volatility in interest rates this year has been particularly troublesome for fixed-income investors. Much of the jump in long-term Treasury bond yields has been due to the expectation of the Federal Reserve tapering its asset purchase programs in 2013. The unrelenting rise in stock prices combined with investors pouring assets into equity-oriented funds at a breakneck pace has also put downward pressure on the fixed-income sector. The recent municipal bankruptcy headlines in Detroit certainly haven’t helped matters either.
These factors have combined to create a panic situation in Treasury bond prices that has sent long-duration ETFs such as the iShares 20+ Year Treasury Bond ETF (TLT) to new lows last week. TLT is currently down over 14% from its May 2013 high and appears to be headed lower.
The fundamental and technical picture for long-term Treasury bonds is certainly weak. Right now the price of TLT is in a persistent down-trend with no hint of stabilization on the horizon despite the Fed’s recent reassurance that it will continue its indefinite $85 billion per month bond buying program. Investors are signaling that the long-term fear of inflation and appetite for risk are trumping the safety of Treasury bonds at this juncture.
Even PIMCO’s Chief Executive Officer, Mohamed El-Erian is recommending that you keep your bond exposure in the short to intermediate-term duration in order to lighten the interest rate risk in your portfolio. He also stated that he feels bonds represent a better value than stocks right here, and I tend to agree with him. Despite the fact that stocks can remain at these levels for an indefinite period of time, I don’t believe that making new allocations to equities at these highs makes a lot of sense.
I still feel that moving forward we are going to see continued volatility in fixed-income for the remainder of 2013. That includes strong price moves, both up and down, in response to changing conditions. One uncertainty that the bond market will be paying close attention to is the selection of the next Federal Reserve Chairman. Ben Bernanke’s term will expire in January 2014 and thus we can expect a new candidate for the post to be narrowed down in the coming months. The new Chairman will have a great deal of pull with regards to future interest rate policy and economic stimulus, which can directly impact both the stock and bond markets. The Fed will also be digesting future economic data in order to make its ultimate decision on QE tapering that includes inflation expectations and employment trends.
I have been recommending for some time that investors consider shortening the duration of their portfolios and consider actively managed strategies for their fixed-income exposure. This includes the use of floating rate notes, short-duration bond funds, and a higher cash position to mitigate the interest rate risk in their portfolio. In addition, you can even consider rising rates funds that will help offset or hedge a portion of your bond holdings.
For those that are considering abandoning bonds altogether in a last ditch effort to put all their money in cash or stocks, I want to wish you good luck. The volatility in stocks will surely return in a swift and tumultuous fashion that catches most investors off-guard. On the flip side, the safety of cash is an alluring alternative that will provide short-term relief without adding any long-term value. The yield on cash is essentially zero and with inflation expectations you will be running at a negative pace. As they say, “it’s a nice place to visit, but I wouldn’t want to live there.”
The right actively managed income strategy can still provide low volatility, current income, and profitable returns. The key is to keep your expectations in line with the current market environment and to utilize the various income alternatives at your disposal.