While everyone’s eyes have been fixed on the government shutdown and looming debt ceiling deadline, the bond market has been making some subtle moves.
The September announcement by the Federal Reserve that it is full steam ahead on their asset purchase programs caused a snap-back rally in nearly every fixed-income sector. Prior to that event, interest rates had been on a meteoric rise that rivaled any such bond market volatility since the mid-1990s.
Now we’re starting to see some semblance of order return to bonds, but figuring out how exactly to attack it must be a nuanced decision. Each sector of the bond market offers its own unique opportunities and risks — and here, we’ll analyze four segments to see which bonds are offering the best value right now:
#1: High Yield Continues Its Hot Streak
One area of the bond market that has been on fire this year is short-duration high-yield bonds, which have continued to crank out substantial income with low volatility. One of my favorite ETFs to access this space is via the PIMCO 0-5 Year High Yield Bond ETF (HYS), which currently is trading near its 52-week highs. The current yield on this ETF is 3.5%.
The advantage of choosing shorter-duration high-yield bonds is that you are further insulated from interest-rate risk in the event that we see another move higher in bond yields. The greater danger to this sector is a stumble in the economy, which would deteriorate the credit fundamentals of the companies that issue high-yield bonds.
That is why I am avoiding longer duration securities such as the iShares High Yield Corporate Bond ETF (HYG). Right now, the higher yield (5.3%) doesn’t match the risk of more substantial price decline should this sector fall out of favor.
#2: Mortgage Bonds on the Move
Click to Enlarge One of the first areas of the market to begin warning us of potential danger back in May was mortgage-backed securities.
The iShares MBS ETF (MBB) is one of the larger proxies for this market, with more than $15 billion in total assets. The bonds held within this portfolio (along with Treasuries) are some of the very securities the Fed has been buying to keep interest rates artificially low.
Since the September decision by the Fed not to taper asset purchases, MBB has been off to the races and is now trading very close to its long-term 200-day moving average. If this fund can climb above that technical level, it might set the stage for a larger comeback in mortgage securities that would lure additional money back into this space.
I typically prefer to play this sector through the expertise of an active manager such as the Doubleline Total Return Bond Fund (DBLTX). I have found the expertise in research, security selection and risk management to be well worth the slightly higher management fee. Meanwhile, it yields 4.6%.