BondSquawk

by Maulik Mody – Bondsquawk.com

July 9, 2010

On account of the Greece and Euro zone debt crisis and the growing concern for the slowing recovery of the U.S. economy, June saw a rise in Treasuries and Corporate bonds as interest rates continued to fall during this period. The flight to quality caused the yields to fall across the curve, with the 10-Yr falling by 34 basis points, a drop of 10.1% and the 30-Yr by 29 basis points, a fall of roughly 7%. The yields on the 2-Yr fell by 16 basis points, bouncing of it’s all time low of 0.59.

This decline in yields explains the gain in the Bank of America Merrill Lynch Fixed Income indices. The Treasury Index gained 1.8%. The U.S. Corporate Bond Index, which consists of Investment Grade bonds, gained 2.06%, after losing 0.6% in May.

The risk aversion was high as depicted by the underperformance of stocks and the high yield sector this past month. Stocks declined throughout the month, falling by 5.39% to end at 1030.71. Although the High Yield Master Index posted positive gains, the volatile sector advanced only 1.30%, which lagged the aforementioned performance of both the Treasury and Investment Grade Index.

This trend is in tune with that observed since the beginning of the new year, where investment grade Corporate bonds have outperformed Treasuries, followed by high yield bonds. Stocks have been seeing losses on a holding period basis. The Merrill Lynch Corporate Bond Index gained 6.09% and the Treasury Index saw a rise of 5.88% since the beginning of 2010. Compare this to the S&P, which lost 7.62% in the same period. The High Yield index too outperformed stocks, showing a gain of 4.74%.

Over the last 5 years, bonds have performed better than stocks as an asset class. A dollar invested in the S&P 5 years back would have lost 13.5 cents by the end of June 2010. High yield bonds, however, which are considered as a risky investment too, returned on average close to 40%, as shown by the Merrill Lynch High Yield Master Index. The Corporate Master Index gained 28.6%, whereas Treasuries outperformed, returning 30.22% over the past 5 years. This high return is mainly due to the rally after the financial meltdown.

If risk is considered to be the standard deviation of monthly returns or volatility, stocks lead the list, having standard deviation of monthly returns of 4.6% over the past five years. High Yield had a volatility of 3.8% over the same period, whereas Corporates and Treasuries showed a volatility of 2.1% and 1.4% respectively.

An overview of the past 5 year and 10 year performance analysis shows that stocks has not proved to be a fruitful investment, owing mainly to the losses experienced after 2008. With this crisis spreading globally, Treasuries and Coporates proved as a safe haven for investors. This outlines the most important risk factor differentiating debt from equity investments. Investments even in risky High Yield bonds has shown higher returns compared to stocks, and with the Fed promising to keep the rates low for a while, this trend can be expected to continue.