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As Stock Rally Falters, Bonds Beginning to Bloom

31 January 2014 in Trading Ideas

With the US stock market off to a 4% drop so far in 2014, a quotation often (but apparently wrongly) attributed to Will Rogers comes to mind: “I’m not as concerned about the return on my money as the return of my money.”

One could understand equity investors being of a similar mindset. In the span of about a week, the S&P 500 found itself back where it was in mid-November, while the market’s current six-month return of just more than 5% has taken a bit of the shine off what was a huge performance by stocks in 2013.

What seems to have investors spooked and bidding up bond prices early in 2014 is the perceived need to seek quality assets in the wake of emerging markets turmoil. Earlier this week, both South Africa and Turkey saw their central banks hike interest rates in an effort to reassure investors, while Russian and Hungarian currencies continued to plummet in global markets.1

The move has helped lift US Treasury prices – and lowered the yield – as investors pile into US bonds in escape of emerging-market assets.

US treasury ladder motifThe US Treasury Ladder motif has gained 2% in the past month; the US Bond Index has risen 1.2% in the same timeframe. For the past 12 months, the motif is down 1.5%; the US Bond Index is flat.

The motif could continue its attractiveness for investors as the Fed keeps working to taper its purchases of Treasuries in an attempt to keep longer-term interest rates lower. The motif’s laddering effect may help to mitigate risk in an environment that sees long-term rates rise, while the Fed continues to have an interest in keeping short-term rates lower.

Corporate bonds have also stepped up in popularity, with the Wall Street Journal noting that bond investors are showing the most confidence in corporate America since the financial crisis, suggesting expectations are high that the US economy will keep rolling even with the Fed tapering its asset buying.2

Purchasers of corporate debt are demanding the smallest interest-rate premium to comparable government bonds since 2007. Demand has also put sales of new junk-rated corporate bonds in the US on pace to surpass last year’s record. Sales of investment-grade bonds in the US this year are already at the highest ever, according to data provider Dealogic, the Journal said.

corporate bonds motifThe Corporate Bonds motif has gained 1.2% in the past month and has increased 1.1% in the past 12 months. The comparable Dow Jones Equal Weight Corporate Bond index is up 1.74% in the past month and down 3.39% in the past year.

For perhaps the best piece of evidence that bonds are back in favor, one need look no further than municipal bonds, which were, as a group, a scourge on investment returns in 2013.

However, just two weeks ago, the Journal reported that investors poured in $103 million into municipal-bond funds, breaking a streak 33-week redemption streak. Redemptions surged last year as rising interest rates combined with skepticism-creating headlines from Detroit’s bankruptcy and speculation that Puerto Rico would see its debt restructured.3

Eventually, the Journal said, fund managers have begun to see value in some munis that were otherwise dragged down in the broad selloff.

california munis motifTake the California Munis motif , for example, which has gained 2.8% in the past month (it’s down 1.7% in the past 12 months). With growing evidence that the state’s budget woes are behind it, its municipal bond outlook is improving, with improving balance sheets, revenue and stabilizing credit ratings from the main three rating agencies.4

While the interplay among economic growth, inflation and the Fed’s watchful eye has yet to play out, many investors have already decided that bond investing may be somewhat more vital in 2014 than the afterthought it was for many in 2013.

1Daniel Kruger, “Treasuries Rise on Refuge Demand as Fed Taper Matches Forecast,” Bloomberg.com, Jan. 29, 2014, http://www.bloomberg.com/news/2014-01-29/treasuries-rise-on-refuge-demand-as-fed-taper-matches-forecast.html.

2Mike Cherney, “Investors Are Hungry for US Corporate Bonds,” WSJ.com, Dec. 15, 2013.

3Al Yoon, “Muni-Bond Funds Break Redemption Streak,” WSJ.com, Jan. 16, 2014.

4“California Municipal Bond Market: 2014 Credit Outlook and Investors’ Perspectives” De La Rosa & Co, January 2014, http://www.sdcounty.ca.gov/economicroundtable/docs/ert2014_Crowley.pdf.

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Historical performance as of January 31, 2014.

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