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Bond-age with discipline Commentary: Investors be nimble and quick
By Michael Kahn
NEW YORK (MarketWatch) -- With the disillusionment of a lost decade in the stock market still weighing heavily in their psyches, investors have been pouring money into the bond market. And with interest rates lower than most people can remember, the rush into fixed income has pundits calling this the next bubble.
Are investors rushing into a bubble? After all, greed blinds people into making ill-advised investments as Pets.com speculators in 1999 know all too well. Real estate investors in 2007 know it, too.
Or does the surge in bond prices signify something more sinister? Fear is the other side of the spectrum of investor emotions and it can blind people just as well as greed.
I put to you that bubbles are built on greed and not fear. If that is true, then the bond market is not in a bubble and will offer nimble investors the opportunity to earn at least a little more than the near-zero return of money-market accounts.
Please focus on the word "nimble." The bond market of today is not like the bond market of yesteryear where we could buy and hold until maturity. It did not matter that the value of those bonds fluctuated because at the end of the bond's life it returned your principal, safe and sound, into your account.
Today's bond market is indeed sitting on a precarious perch. If interest rates rise, bonds will fall in price and there is an awful long way to go before some realistic floor is reached. That means bond investors can lose money -- a lot of money.
Fortunately, or unfortunately, in the deflationary tinged environment of today, I do not see interest rates rising soon. However, there is no doubt in my mind that all the liquidity dumped into the system will eventually cause them to go up. I am not talking about a Weimar Republic-style hyperinflation but the sheer supply of bonds depends on huge demand to soak them up. Any wavering in investor appetite for bonds can get the rising interest rate ball rolling.
That's why being nimble is a necessity. Investors will have to treat bonds as professional traders treat stocks. Get in, watch them closely and then get out when things look shaky.
The iShares Barclays 7-10 Year Treasury Bond Fund (IEF 98.18, -1.08, -1.09%) shows how money poured into the safety of government issued bonds when the economy looked poor. (See chart)
Bonds tend to turn before stocks and in May 2007, this exchange-traded fund (ETF) started what was to become the first leg of a stunning 40% rally. After a bit of rest, the second leg of the rally began just as stocks were in their final meltdown phase in October 2008.
Fast forward to today and we see what appears to be another moonshot of a rally that is fast approaching the highs of 2008. The bond market is not happy about the state of the economy and investors are fleeing stocks for the perceived safety of bonds.
Income Security Recommendation December 2011 Issue.
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