Should You Load Up on Bond ETFs Now?


Given that it is tough to find high-yield blue chip stocks nowadays — especially because of the big gains in the equities markets — it’s certainly worth taking a look at fixed-income alternatives, especially since the Treasury yield is near 3% (for 10-year securities).

So is it time to shift some assets into bond ETFs like the iShares 20+ Year Treasury Bond ETF (TLT) or iShares 7-10 Year Treasury Bond ETF (IEF)?

Well, unfortunately, there’s no easy answer to that question.

Predicting interest rates and Treasury yields is incredibly tough. Even the world’s best bond investors have troubles, a la Bill Gross, the co-CIO of Pimco, which manages $1.9 trillion in assets. While Gross is often referred to as the “bond king,” his Pimco Total Return Fund (PTTAX) in 2013 posted its first loss since 1999. All told, his clients pulled a whopping $41.1 billion of their holdings out of Pimco Total Return.

The reason for the subpar performance in 2013 was skyrocketing bond rates, with the 10-year Treasury yield surging from as low as 1.66% to just above 3%. Bond yields and prices have an inverse relationship — that is, when rates rise, prices on existing securities drop to make them worth buying — thus bonds yields’ rise to 3% meant pain for the price of bonds.

So, if you expect interest rates to continue their climb, right now probably isn’t the best time to snap up bond ETFs like the TLT and IEF. Treasury yields just might not be enough to make up for the price erosion.

However, that doesn’t necessarily mean that if you do dip in, that you’ll suffer big losses. Bond markets typically aren’t terribly volatile. The biggest threat of stark moves is runaway inflation, like what occurred in the 1970s and led to wrenching losses for investors and spurred the Federal Reserve to take extremely restrictive actions.

And right now, there’s no sign of an inflation outbreak.

Consider that the biggest driver for inflation tends to be wage pressure, and there’s no indication of this. Corporate America has remained stingy with compensation, and the job market still is far from robust, as seen with the December jobs report. The U.S. economy added a shockingly low 74,000 jobs, which was well below the consensus forecast of 197,000 jobs. Writes Dan Burrows:

“But now that the books are closed on 2013, it’s clear that the job market gained no momentum year-to-year. For all of 2013, the labor market added an average of 182,000 jobs a month, vs. 183,000 a month in 2012.”

It’s true that the Fed is looking to wind down its bond buying program, and that the “taper” is officially on. But the effort has been minimal so far, with the monthly amount dropping from $85 billion to $75 billion. And any future reduction should be gradual considering inflation is sitting close to 1% and far below the 2% target. If the Fed tightens too much, the U.S. economy could very easily lose momentum.

So we might actually see a little more volatility than normal in interest rates, but there are few signs that yields will enjoy a major move on the upside.

And that should be good for bond ETFs like the TLT and IEF.

Bottom line? It’s always good to have some exposure to bonds. So while now might not the time to make a significant dive into bond funds, the environment isn’t so risky that you can’t afford a little extra fixed-income exposure.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO StrategiesAll About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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