This month we have seen a marked increase in volatility in the bond markets. Bond mutual funds have been in redemption mode and have found themselves rushing for the door to sell positions to generate needed cash. When these adjustments happen there are always opportunities that result. Your clients should be aware of these opportunities as we feel that on a near-term basis this move is likely overdone. The markets have way over valued the comments of Ben Bernanke. His comments are that the Federal Reserve (Fed) will continue to support the market with bond purchases and if the U.S. economy continues to improve they would gradually reduce their purchases. He also said that if the economy slows they would INCREASE the purchases.
Let’s face it, quantitative easing (QE) is not normal. It is a radical treatment for a very sick patient. When the patient gets better, the radical medication is no longer needed. Credit opportunities abound in our opinion during times like this because liquidating bond funds sell what they can. The move on the 10-year Treasury puts the yield up at the 2.4% level, which should provide short-term resistance. The real opportunity is in credit products like lower grade corporates and municipals. These markets have sold off in sympathy and provide some very attractive buys. Remember, credit tends to tighten as economies improve. High Yield tends to be more correlated with equity markets but can involve more volatility than high-grade securities. That is what we are seeing but we will likely be paid well to take the risk.
Both Bill Gross and Jeff Gundlach note that the world economies are slowing and that there is no sign of inflation in the United States. This gives the Fed a long leeway to keep up the QE, although it has to and should be removed as soon as the economy can exit the “Intensive Care Unit.” We feel we are almost there. Thus, our feeling would be to stick to the playbook of maximizing credit risk in fixed income portfolios according to the client’s risk tolerances and to minimize allocation to high grade and U.S. government obligations. We feel the opportunity will continue to be in corporates and municipals.
At the end of the day, we think this is time for some selective buying while everyone is trying to get out the door. Do we think that rates will rise in the future? Yes, we do but we think the Fed will restrict the rate of ascent keeping the short-term rates near zero and longer rates in check. As portfolio advisors, it is not our job to call interest-rate movements; it is to find value for the investor. Let’s not start fighting the Fed yet. Keep to what works and don’t be shaken by what is likely a correction. Equities and Credit should be accumulated here.
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