4 Bonds For Falling Off the Fiscal Cliff

 

As we approach year-end and the Fiscal Cliff, volatility continues to plague the market as risk-assets experience wild swings. As mentioned in “Fund Managers Underweight Risk Leave Little Support as Fiscal Cliff Approaches,” a fall in risk assets, in particular stock prices, should translate to higher U.S. Treasury prices. Last year’s debt ceiling debacle proved that Treasury yields actually fell as investors flocked toward safe-haven assets.

Here are 4 Bonds that should perform well in a flight-to-quality scenario if the U.S. falls off the Fiscal Cliff.

 

When you look at these bonds, it is easy to think that the yields are too low. Keep in mind that the stated yields are returns generated if the bonds are held to maturity. In a flight-to-quality scenario, the time horizon typically is much shorter so the focus is on the price gain resulting from a change in yields. So if yields fall in an even fashion, bonds with a high duration will gain in price than ones with a lower duration.

The first two bonds are the current 10 and 30-Year U.S. Treasuries. The remaining two are U.S. Treasury Strips which are also known as “Zeros” since it has no coupon.

Strips are securities backed by U.S. Treasuries where the principal and interest component of the future cash flows are separated. As a result these high quality securities are at a significant discount since principal is returned at par at maturity. So the difference between the purchase price of the zero and its face value when redeemed is the investor’s return. Due to these characteristics, the duration to changes in yields is higher than its coupon paying counterpart.

As you can see, there is a difference in yields between the Principal and Interest Strips even though the maturities are the same. This is typically driven by taxes. Interest Strips accrue interest over time and are taxed each year. This is the case even though interest is not paid until the bond matures. As a result, Interest Strips trade higher in yield due to this tax treatment. Please consider this when deciding which bond is for you.

Finally, an investor can use margin as an additional tool to enhance and amplify returns.

Treasuries across the yield curve typically perform well when volatility hits the market. As investors run toward safe-haven assets, yields will fall. Hence, Treasury bonds with longer durations should outperform as risk assets drop in price.

Information and market quotes on the bond investments are provided by Trade Monster’s Bond Trading Center.

As always, every investor should perform their own due diligence when making their investment decisions.

If you have any questions or feedback on anything regarding the economy, markets, and bonds, feel free to Contact Us. We would be delighted to respond.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

 

4 Bonds For Falling Off the Fiscal Cliff

 
 
 
 
 

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