September 2, 2010
Disappointing economic numbers in recent times have pointed towards a slowing economic recovery and increased demand for safe assets. As a result, bonds have outperformed most asset classes even amidst a heated debate of a bond bubble haunting the markets. Now that September kicks off on a positive note as stocks advance and economic data improves slightly, investors again start pondering over the question that has troubled them for months. Is this the signal that the economy is turning around and heading towards faster recovery and stronger growth? Is this the right time to exit bonds and enter stocks?
In my view, we are far from the “right time” to exit bonds and enter stocks. The recent rally to me is a relief rally at best, mainly as desperate investors clung to yesterday’s slightly better economic data to try and make up for Dow Jones worst August in a decade. An unemployment hovering around 9.5% and reduced consumer spending among other issues keep me from believing that the recovery is accelerating or the economy strengthening. Economic conditions do not seem to be improving considerably anytime soon and it is going to be a slow recovery over a few years. Mark Hulbert from Marketwatch in his article below suggests that a good bet would be to invest in bonds with shorter maturities, so this way not exiting bonds completely and at the same time, “moving closer to the exit door”.
Is it, or is it not, a bond bubble?
That is the question — at least for bond-market investors these days.
On the one hand are those convinced that bonds are wildly overvalued, propelled ever upwards by naïve investors who gullibly extrapolate recent returns into the indefinite future. Read Hulbert’s Aug. 25 column.
On the other hand are those who believe that overwhelming deflationary forces will be at play in the economy for a number of years to come, and because of those forces bonds will be the most attractive asset class for at least the short and intermediate terms. Read Nick Godt’s Aug. 20 column.
What’s a bond investor to do?
For insight, I turn — as I always do in this section of each month’s Trading Strategies — to the investment advisers with the best records.
Their consensus opinion about bonds: Keep maturities short.
The accompanying table (check article for table) lists those bond mutual funds that are most recommended right now by the advisers on the Hulbert Financial Digest’s monitored list who have beaten the market over the past decade. The table also shows the average effective maturity of the bonds owned by these funds (as calculated by the fund family).
The average maturity across all the funds in the table is just under five years. Furthermore, that the fund on the list with the longest effective maturity — at 8.9 years — is one that invests in inflation-protected Treasurys. One way of interpreting this: The only way that the top performers are willing to go even 8.9 years out the maturity spectrum is if they are protected against the risk of higher inflation.
The bottom line? The top performers aren’t shunning the bond market altogether. But they aren’t making aggressive bets on the sector either.
In effect, they seem to be saying: While there is no reason to leave the party immediately, you nevertheless might want to start moving closer to the exit door.
Posted by Maulik on 