Since the second round of quantitative easing (QE 2) was announced by the Fed, US bonds as a whole (whether corporate or government) have been under pressure. It appears that the market is finally tuning into a few facts. The facts being that inflation is already here, rates are going to have to rise, and bonds hold more risk than usual. Typically, bonds are held in a portfolio to limit risk and volatility in a portfolio. In the current environment, bonds are not offering the risk/return reward that typically exists. The impetus to my critical eye on bonds is the unexpected reception of QE 2. In the previous runs of quantitative easing, the market reaction was quite different than that. This time around, reality appears to have finally set in. When conditions change, like they have, investors must be nimble to cut losses.
To manage long-term, downside risk in portfolios, I created an investment strategy that seeks to limit steep losses. In the last few months (since QE2), I am seeing an undesirable trend in the bond markets; that trend being lower lows, and lower highs, which is indicative of a breakdown. Most of the pressure on bonds is a result of government policies and currency maneuvers such as money creation, bailouts, and devalued currencies. Bonds have also started to drop below their 200-day EMAs, which is a sell signal in my opinion.
So what has changed, or is changing? Global investors are realizing there is risk in bonds. According to a Morgan Stanley study, a one percent jump in 10-year US Treasury yields would wipe out $1.6 trillion in bond market value. Be sure yields will go up. Just as investors jumped from stock mutual funds and poured money into bond mutual funds to escape the falling stock market, they will be very quick to move out of bonds when they see their conservative investments lose value. The bottom line is that bonds can exhibit stock-like returns on both the upside and downside.
If we look around the world of debt, what do we see? Starting close to home, we find bankrupt cities and states. Going up the food chain, we find the US running record deficits and racking up more debt. Japan is in the same boat with the US and Europe joining the debt party with bailouts of entire countries.
At this point I see more downside coming than upside for bonds. I would rather have conservative assets in a place that offers more stability and growth opportunity than just holding outright bond funds. All of these issues have lead me to moving my clients out of various bonds that are holding vast amounts of risk in what are thought to be less volatile assets.
Do you (or your advisor) still have part of your portfolio invested in bonds because you think it is “safe?” If so, you may want to contact us at 913.693.7918 to schedule your free portfolio evaluation.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.
