For months, investors have shunned bonds as the Fed-fueled risk rally pushed skyward. This ended a long love affair with fixed-income that ended late last August amid talk of a “bond bubble” as yields plunged and corporates started issuing 100-year paper to cash in on the frenzy. In the months that followed, conservative Treasury and investment grade bonds sank like a stone.
But things are changing now as stocks contend with overhead resistance and new threats to the bull market and the economy loom.
You could see this on Monday in the way T-bonds surged in response to the surprise credit watch downgrade of the U.S. by Standard & Poor’s analysts. In the process, bonds have broken out of downtrend resistance that has kept them pinned since last summer.
Fund flow data corroborates the shift. According to the folks at EPFR Global, all bond fund suffered cumulative outflows between November and February while stock funds enjoyed big inflows. Since the beginning of February, the flows have reversed.
Investors are now focusing on inflation-protected fixed-income funds including float rate products while continuing to shun municipal products out of fear of fiscal woes at the state and local level.
And investors have a right to be nervous about stocks.
The S&P downgrade watch sets the stage for deep fiscal tightening in Washington at a time when economists are busily marking down Q1 GDP growth estimates. The euro zone continues to struggle with talk of a Greek debt restructuring. Surging food and fuel prices have put a damper on corporate profit margins and consumer confidence. And the Fed’s $600 billion QE2 program is set to end.
Inflation expectations fell all week as traders rushed into long-term Treasury bonds. And this is pushing the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT) up and out of downtrend resistance.
Investment-grade corporate bonds also look attractive at current levels with the iShares Investment Grade Corporate Bond Fund (NYSE: LQD) enjoying a surge of buying interest. I have already recommended LQD to my newsletter subscribers.
Yes, this “anti-inflation, economic slowdown” message is at odds with what’s happening in commodities with gold and silver pushing to new highs. But based on other signs of an impending slowdown — from a huge shift by investors into defensive stocks such as consumer staples to a drop in market breadth — I believe now is the time to start cashing in stock market profits while looking for opportunities in fixed-income again.
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