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5 Reasons to Give Bonds Another Chance

It's time to turn this sell-off to your advantage

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That galloping noise you hear is the sound of bond investors tripping over one another to get to the exit door.

This week, TrimTabs reported that bond mutual funds and ETFs have seen $103.5 billion in redemptions since June 30 — a whopping 2.7% of their total value. And it’s no wonder: The bond market has been slammed by rising rates across the board, with only the shortest-term (and lowest-yielding) funds able to sidestep the carnage. But now, with major losses already in the books, is it time to give bonds another look?

It just might be.

Here are five reasons why bonds offer a contrarian opportunity for investors and traders alike:

#1: Taper Uncertainty Will Soon Go By the Board

The main issue plaguing the bond market has, of course, been the prospect that the Federal Reserve will taper its quantitative easing policy. The selling has built upon itself amid the ongoing uncertainty, with falling bond prices driving fund outflows, which in turn have caused prices to fall further and fueled a vicious circle. At this point, however, the fact that tapering is going to occur — at some point — is largely factored into market prices.

What isn’t factored in is the extent of the taper — and herein rests the uncertainty that continues to pressure the market.

Nevertheless, the issue that might be getting lost in the clamor right now is that investors are going to gain much more clarity on these issues in the next month. The first hurdle is today’s Fed minutes, which in theory should provide more insight as to the timing and extent of tapering. Then, on Sept. 6, investors have the August jobs report — a key number since the Fed’s decision-making process hinges on incoming economic data. Finally, Sept. 17-18 is the date of the next Fed meeting — and the point, presumably, at which Ben Bernanke & Co. will announce their final decision on the taper.

The consensus expectation is for a reduction of $20 billion to $25 billion per month from the current $85 billion. However, with four weeks to go until the announcement and a key number on its way in the interim, there’s still substantial latitude for a shift. One important result of this ongoing uncertainty is that bonds are having a tough time catching a bid right now.

Once the September Fed meeting is out of the way, however, investors will have much more clarity regarding the outlook for quantitative easing. And, most likely, they will see that the Fed intends to wind down the program in a measured way that’s unlikely to disrupt the markets. The resulting dissipation of uncertainty should begin to make bonds look like a much better buy.

#2: Yields Are Much More Attractive Now Than They Were in the Spring

Already, the yield on the 10-year note sits at 2.81%, vs. 1.63% at the beginning of May. At this level, bonds offer a more competitive option relative to stocks given the yield of approximately 2% on the S&P 500 Index.

Municipal bonds might offer an even better deal for investors in high tax brackets: At its current level nearly 8% below from its spring high, the iShares National AMT-Free Muni Bond ETF (MUB) offers a 4.15% yield for investors in the 33% bracket and 4.60% for those who pay the top 39.6% rate.

Corporate bonds currently yield more than 3.5%, up from the 2.6% range in early May, while the yield on high-yield bonds has risen to 6.55% from 5.24% on May 9 (according to the Federal Reserve Bank of St. Louis database).

A hockey-stick pattern for the ten-year yield

A hockey-stick pattern for the ten-year yield

Just because yields are higher doesn’t mean they can’t go higher still, but the news flow has the potential to grow more positive in the months ahead.

For instance, a key factor weighing on the bond market has been the consensus view that economic growth is improving. In recent years, however, these periods of rising optimism about the economy generally have proven to be false starts. Or as Bill Gross put it yesterday, “Faster growth ahead? Show me.”

Article printed from InvestorPlace Media,

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