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Keep Your Cool Over Bond Yields

Higher-yielding instruments will yet again be en vogue. Just wait.


A wise observer of financial markets three centuries ago noted that “the expectation of an event creates a much deeper impression on the exchange than the event itself.” Like a patient dreading root-canal therapy, bond investors have worked themselves into a cold sweat over the prospect (still far off in the distance) that the Federal Reserve will someday raise interest rates.

In the past month, the price of a typical long-dated Treasury bond has dropped 8%. Many “leveraged” closed-end bond funds, which use borrowed money to enhance returns, have fallen even more.

The panic selling has gripped interest-sensitive stocks, too, with REITs (IYR) and utilities (XLU) down roughly 10% from their spring highs. Master limited partnerships (AMLP) are off about 5%.

My advice: Take a deep breath, exhale, sip a cup of tea (iced if you’re south of the Mason-Dixon line) and flip on some quiet music. The frantic worry over what Ben Bernanke might, or might not, do next is misplaced.

Let’s be clear, at the outset, about the debate now going on within the Federal Reserve. Some members of that august institution want to “taper” the central bank’s aggressive purchases of bonds and mortgages. However, not a single Fed official has made a peep about actually raising rates.

That’s an important distinction. Once investors realize that short-term money market rates are going to remain unchanged (near zero) for the rest of this year and probably well into 2014, the lure of higher-yielding instruments will prove irresistible. Many of the folks who have been dumping these vehicles in recent weeks will come streaming back in.

What will bring them back? The economic data.

For the past four weeks, bond bears have feasted on the stronger-than-expected April jobs report. However, the monthly employment report is notoriously unreliable and often subject to large revisions. The much broader palette of indicators captured in, for example, the Chicago Fed’s national activity index shows a definite slowdown since the beginning of the year.

What’s more, the even timelier ISM purchasing managers index, released Monday, reveals that activity in the manufacturing sector (a bellwether for the overall economy) contracted for the first time since the official end of the recession in mid-2009.

I could go into more detail. We could talk about the two-year slide in copper prices, or the more recent plunge in lumber (which doesn’t bode well for the housing recovery). But enough is enough. There’s no economic boom underway, or on the horizon. Bond yields will calm down again soon.

Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk “value” approach has won seven “Best Financial Advisory” awards from the Newsletter and Electronic Publishers Foundation.

Article printed from InvestorPlace Media,

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