Bonds are supposed to be safeinvestments . But what
mostfixed-income investors don't realize is that bonds have
rarely been more risky. That's because with interest rates near
record lows, bond prices are vulnerable to huge losses if
interest rates rise.
And that's exactly what they've been doing.
May was the fourth-worst month in 20 years for the bondmarket .
Fund-flow data showed aggressive selling in a broad spectrum of
fixed-income markets, with the
iShares Barclays 20+ YearTreasury Bond (
falling 5.2%, its biggest drop since the financial crisis.
The recentwave of weakness hitting the bond market has many
investors asking if this is the beginning of a longer-term trend
of rising interest rates.
According toanalysts at
Goldman Sachs (
, the answer is yes. In a recentnote , Goldman warned its clients
on the danger of rising interest rates.
"At the 10-yearmaturity , U.S.government bond yields are now back
at the middle of a broad 1.5% to 2.5% range in place since the
summer of 2011. Our bond valuation models ... indicate that
10-year Treasury yields should currently be trading in the upper
half of this range (between 2.1% and 2.5%), taking into account
the decline in systemic risks and the brightening U.S. economic
outlook. Our model estimates (and, consistently, our forecasts)
show 10-year Treasurys reaching 2.5% in the second half of
thisyear , with German Bunds trading at 1.75%."
Goldman'sbearish call on bonds is being driven by its more
optimistic view on economic growth, saying that bond markets are
overbought relative to underlying economic conditions and that
the stronger than expectedpayroll report compensated for recent
weakness in economic data.
But Goldman also makes note of the Federal Reserve, the
800-poundgorilla in the bond market. After four years of steadily
growing quantitative easing,the Fed is talking about scaling back
the size of its monthly bond purchases. And that is already
having a big impact on fixed-income markets, with bond investors
front-running the Fed and taking profits on the biggains that
bonds have produced in the past few years with the Fed bidding
If the Fed scales back its bond purchases, theTreasury market
will struggle to replace its biggest buyer, and that will have a
devastating effect on bonds and bond investors.
Interest rate movement is not thought to be fickle. Interest
rates are highly directional and tend to rise and fall in
multiyear patterns based upon business cycles. That means this
initial turn in the bond market could be an early signal of a
larger trend as investors demand more return for the risk of
buying a bond whenstocks look cheap andearnings are at an
But while many investors will use Goldman's opinion as a chance
to reduce exposure to weakness in the bond market, it is also an
opportunity toprofit from the turn.
ProShares UltraShort 20+ Year Treasury (
is anexchange-traded fund (
) that gains in value when interest rates rise. With yields
jumping in the past month, shares of this fund have been hot, up
a market-beating 10%.
But this is no Johnny-come-latelyETF . With assets under
management of $4 billion and average dailyvolume of 5.8 million
shares, it ranks as one of the most popularfunds in the market,
able to accommodate even the biggest players on the Street. A
0.92%expense ratio is high compared with the entire ETF space but
only slightly higher than a competing exchange-traded note, the
iPath US TreasuryLong Bond Bear ETN (Nasdaq:
On the tax front, although many
limit potentialcapital gains by exchanging lower-cost bonds in
their portfolios for redeemed ETF shares, this fund conducts the
transaction incash and then enters into independent swaps. That
makes shareholders liable for capital gains, where the fund has
been forced to make a number of sizable distributions to its
Risks to Consider:
Treasurys are still viewed as defensive, which means weakness
in theequity market could fuel inflows back into bonds. Although
stocks continue to trend higher, any weakness in theeconomy would
shift capital out of stocks and back into bonds.
Action to Take -->
Goldman is warnings its clients to expect higher rates in the
second half of the year as the Fed signals its desire to taper
its participation in the Treasury market. As the world's biggest
buyer of Treasurys, the Fed's decision will have a profound
effect on the market. That poses a huge threat to bond prices,
making this the perfect time for investors to review their
exposure to the bond market or even profit from rising yields
with the ProShares UltraShort 20+ Year Treasury ETF.
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