Interest rates have been going up and have affected not only mortgage rates but U.S. Treasuries and bond funds as well.
Reader Eric was concerned about his bond index fund holdings in his 401k as he read Kiplinger’s “A Tipping Point In Bonds:”
A 27-year-long bull market in bonds is over and a brutal bear market is under way, says Tom Atteberry, co-manager of FPA New Income (symbol FPNIX). That’s bad news for bond investors, particularly those holding Treasuries and municipal IOUs.
Atteberry, who spoke with us at the annual Morningstar Investment Conference in Chicago, says there’s good reason to believe that the run-up in Treasury yields that began late last year will continue. Between December 18 and May 28, the yield on the ten-year Treasury has zoomed from 2.04% to 3.67%. That has led to big losses for holders of Treasury bonds because bond prices move inversely with yields. Year-to-date through May 28, the Barclays Capital US Treasury 10-Year Term index has lost 7.9%; an index of Treasuries with maturities of 20 years and longer has plunged 22.2%
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The arguments for the sell-off in bonds are well known. The U.S. is issuing an enormous amount of debt — Pimco bond guru Bill Gross estimates that gross issuance in 2009 will total $3 trillion. And eventually, once the deflationary undertow of unemployment and slack capacity in the U.S. weakens, inflation will move front and center in the minds of investors.
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Atteberry’s thesis spells trouble for municipal bonds, which analysts have been pointing to for months as attractive alternatives to Treasuries. Interest from muni bonds is free from federal taxes, and the sector historically has seen extremely low default rates. Thanks to those benefits, munis have historically offered about 80% of the yield of Treasuries.
As munis were pummeled during the panic of 2008, they at one point offered twice the yield of Treasuries, making them even more attractive than usual. As long as munis offered a substantial yield cushion over Treasuries, they didn’t necessarily stand to suffer from a rise in government-bond yields.
But as bond investors regained their appetite for risk in 2009, they pushed up muni prices — and pushed down their yields — to the point where that cushion has essentially disappeared. As of May 22, the yield on ten-year triple-A-rated municipal bonds had fallen to 81% of the yield on the ten-year Treasury.
Nobody knows for sure how this bond debacle will play out. Some of my clients have been holding VBTSX, and the change in price has been negligible.
From my vantage point, the solution to deal with a potential drop in fund prices due to higher yields is the same as if you were invested in equities. There is no need to guess or panic but simply track the trend.
How?
You use the same sell stop discipline as you would if you were invested in an equity mutual fund/ETF. Find out the price you paid for the bond fund you are holding and apply a trailing sell stop of 5% or 7% or whatever fits your risk profile best.
If the long-term rally in the bond market eventually comes to an end due to higher yields, the trend will reverse and trigger your trailing sell stop point. If you owned this bond fund for a long time, chances are that you will be locking in profits. If you have just established the position, the trailing sell stop will limit your losses.
The investment methodology applied with trend tracking does not change because you are invested in bond funds vs. equity funds. It is designed to keep you in the market while prices are going your way and out of it with minimum losses before disaster strikes and annihilates your portfolio.
Comments 2
Buy Vanguard’s Short Term Investment-Grade Bond Fund (VFSTX or BSV) or if you are more aggressive Vanguard’s High Yield Corporate Bond Fund (VWEHX) and I think you will see good returns over the next year. Stay away from Treasuries. Keith
I like and have a position in TBT (2x short) on the Lehman 20 yr bond index. If treasuries are gonna tank like we think they are, we'll be OK with this one.