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Your Money: Before Dumping Bonds, Consider Why You Have Them

June 28, 2013 by Leave a Comment

You can hardly blame them. Investors have been fleeing bonds in droves; a record $76.5 billion poured out of bond funds and exchange-traded funds during the month of June through Wednesday. That exceeds the previous record, according to TrimTabs, when $41.8 billion streamed out of the funds in October 2008 and the financial crisis was in full force.

But the rush for the exits really means one thing: investors are betting that interest rates are about to begin their upward trajectory, something that’s been expected for several years now. Their cue came from the Federal Reserve chairman, Ben Bernanke, who recently suggested that the economic recovery might allow the central bank to ease its efforts to stimulate the economy. That includes scaling back its bond-buying program beginning later this year.

So the big fear is that interest rates are poised to rise much further, driving down bond prices; the two move in opposite directions. A Barclays index tracking a broad swath of investment-grade bonds lost 3.77 percent from the beginning of May through Thursday, according to Morningstar. United States government notes with maturities of 10 years or longer, however, lost an average of 10.8 percent over the same period.

Making a bet on interest rates is no different from trying to predict the next big drop in stocks, or jumping into the market when it appears to be poised to surge higher. These sort of emotional moves are exactly why research shows that investors’ returns tend to trail the broader market. And it’s also why many financial advisers suggest ignoring the noise, as long as you have a smart assortment of bond funds that will provide stability when stocks inevitably tumble once again.

“It’s a futile game to base portfolio moves on interest rate guesses,” said Milo Benningfield, a financial adviser in San Francisco. “We don’t have to look any further than highly regarded Pimco manager Bill Gross, whose horrible interest rate bet against Treasuries in 2011 landed him in the bottom 15 percent of fund managers in his category that year. Investors should take a strategic approach designed around the reason they hold bonds — and then sit tight whenever hedge funds and other institutions shake the ground around them.”

The main reason longer-term investors hold bonds, of course, is to provide a steadying force. And though today’s lower yields provide less of a cushion — the 10-year Treasury is yielding about 2.5 percent — bonds still remain the best, if imperfect, foil to stocks.

“The role of bonds in a portfolio has always been to be a ballast or a diversifier to equity risk,” said Francis Kinniry, a principal in the Vanguard Investment Strategy Group. “And that is very true today. Yields are low, but this is what a bear market in bonds looks like.”

So, yes, losses are indeed more probable than they have been in recent years. From 1976 through Jan. 31, 2013, high-quality bonds yielded an average of 7.3 percent, according to a recent Vanguard study, which provided a nice cushion. For instance, if you had a portfolio of 60 percent stocks and 40 percent bonds — and stocks fell by 20 percent — the overall portfolio would have lost 9.1 percent. If the market plummeted 40 percent, the entire pile of money would be worth 21 percent less.

The situation is a bit different now. Assuming a more conservative average return on bonds of 1.9 percent — a reasonable estimate based on bond yields now, according to Vanguard — the same 20 percent drop in the stock market would cause the overall portfolio to decline by about two percentage points more, or 11.2 percent. If the market plummeted by 40 percent, the portfolio would lose 23 percent.

“Investors have been conditioned by higher bond yields going into both bear markets in the last decade to believe that bonds will substantially offset stock declines,” Mr. Benningfield added.

So perhaps the loss from the bonds somehow feels worse because it’s not something investors are accustomed to. And the memories of the stock market collapse of 2008-9 are still fresh enough. “People are using adjectives like ‘blood bath’ and ‘devastation,’ but we are talking about a negative 3 percent return,” said Mr. Kinniry, referring to the Vanguard Total Bond Market Index fund, which is down by that amount year-to-date.

Even the big bond market sell-off in 1994, which many refer to as a “massacre,” doesn’t seem quite as violent as that moniker suggests. As Mr. Kinniry points out, the same index fund lost 5.3 percent that year, after interest rates spiked by 2.83 percent. If the same sort of situation were to play out now, he said the returns would be significantly worse because bond yields are lower than they were back then. “You might lose about 8 percent,” he said, adding that losses could be deeper depending on how quickly rates rose, among other factors. But typically, “we’re talking about single-digit losses.”

Still, some advisers suggested taking a closer look at your overall allocation to stocks, particularly if you’re not well diversified, since bonds will provide less protection.

For most investors, holding bonds through low-cost index funds remains the most prudent course. People who invest in individual bonds don’t have to worry about fluctuations in their price because they can continue to hold the bond and collect their interest payments until maturity, at which point they’ll collect its face value (unless, of course, the bond issuer defaults). But you need to have a good pile of cash — some experts say $500,000, even more — to assemble a diversified portfolio of municipal and corporate bonds (though you don’t need quite as much for Treasuries, since they’re backed by the government).

You can figure out how sensitive your fund is to interest rates by looking at its duration, which essentially measures how long it will take to receive all of your money back, on average, from interest and your original investment. Generally speaking, for every percentage point that interest rates rise (or fall), a bond’s value will decline (or increase) by its duration, which is stated in years. Bond funds with shorter durations are less susceptible to interest rate risk — the faster a bond matures, the thinking goes, the more quickly you can reinvest the money at a higher interest rate.

That means a fund like the Vanguard Total Bond Market Index fund, which has a duration of 5.5 years, would decline by about 5.5 percent. But since the fund also pays investors income — it has a yield of about 1.7 percent — it would actually only post a total loss of about 3.8 percent. (Future returns would be one percentage point higher, too, thanks to the rise in rates).

But if even that feels too risky, experts say you can put some of your bond money into a diversified index fund with an even shorter duration. The trade-off, of course, is that you will earn less income. That might not matter once you remind yourself why you own bonds at all.

Article source: http://www.nytimes.com/2013/06/29/your-money/before-dumping-bonds-consider-why-you-have-them.html?partner=rss&emc=rss

Filed Under: Economy News Tagged With: , ,

Moody’s Downgrades Hungary

November 26, 2011 by Leave a Comment

Moody’s said late Thursday that it was cutting Hungary to a speculative rating of Ba1 from Baa3, its lowest investment grade, and was maintaining a negative outlook on the debt. The agency cited its doubts about whether the government of Prime Minister Viktor Orban would be able “to meet its targets on fiscal consolidation and public-sector debt reduction over the medium term, in view of higher funding costs and the low-growth environment.”

The benchmark Budapest stock index fell 3 percent, while the currency, the forint, and Hungarian bond prices sagged.

While Hungarian bonds had been trading at levels suggesting investors already treated the debt as junk, Mr. Orban had said Nov. 18 that Hungary would seek “an insurance-type agreement” from the I.M.F. in a last-ditch effort to keep its investment grade.

The Economy Ministry, in a statement cited by Reuters, called the ratings agency’s move the latest in a string of “financial attacks against Hungary.”

The Hungarian downgrade was just one of several to European Union countries. On Friday, Standard Poor’s cut its rating for Belgium to AA from AA+, still investment grade, but said the outlook was negative. And Fitch Ratings on Thursday cut its rating on Portugal to junk, citing similar concerns about the trajectory of government finances.

The biggest ratings question hanging over Europe now is whether France, which holds a coveted triple-A rating from all the major agencies, will be able to hang on to its status. A downgrade of France would have painful repercussions for the European bailout fund and for the euro.

Hungary’s public debt is uncomfortably high for an emerging-market country, equivalent to about 81 percent of its gross domestic product, a figure the government hopes to reduce to 50 percent by 2018. The budget deficit is relatively benign, and Mr. Orban has made keeping it under control a hallmark of his leadership, targeting a level of 2.5 percent of G.D.P. next year.

Moody’s warned that the outlook for the economy and government finances was being increasingly clouded by slowing growth, higher interest rates stemming from the euro crisis and the weakening of key export markets. Those risks are magnified by the fact that two-thirds of government debt is denominated in foreign currencies.

Hungary got a €20 billion, or $26.5 billion, bailout from the I.M.F. and European Union in 2008; it exited the fund’s stewardship last year.

Mr. Orban has enacted tough measures, widely described as “unconventional,” to keep the economy afloat. He has nationalized pension funds, imposed new taxes on services and decreed that Hungarians, many of whom borrowed in other currencies to finance their homes during the credit boom, can pay off their foreign-currency-denominated mortgages at artificially favorable rates — at the expense of mortgage lenders.

But those measures, many of which are one-time events, have run afoul of the I.M.F. and European Union, and some of them will probably have to be dismantled as the price of any new deal.

Tathagata Ghose, an economist with Commerzbank, wrote in a research note that the credit downgrade was not unexpected, as the Economy Ministry had itself suggested the action was imminent. “The negative connotation in terms of dwindling foreign capital participation is obvious,” Mr. Ghose said. “But, there could also be a positive outcome: We think that a much needed reversal to the present policy framework may finally be in prospect.”

Article source: http://www.nytimes.com/2011/11/26/business/global/moodys-downgrades-hungary.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: , ,

Stocks Decline a Day After Fed Announced Stimulus Measure

September 23, 2011 by Leave a Comment

Several factors contributed to the heightened gloom, including new signs of political paralysis in Washington, Europe’s continued failure to resolve its debt crisis and indications of economic stress in developing countries that had been strong.

While the Fed’s measures to lower interest rates could increase growth a bit, some economists worry that the scale of the problems call for more stimulus efforts globally, but other countries are not cooperating.

With investors so nervous, the markets may rebound over the next few days, as volatility and big swings of 3 and 4 percent have become more common. On Thursday a downcast mood appeared across the board.  Stocks plunged about 5 percent across Europe and in Hong Kong, and more than 3 percent in the United States.

“Today, we really seem to be stuck in a negative spiral,” said Matthias Jasper, head of equities at WGZ Bank in Düsseldorf. “Investors just want to keep their exposure low and watch from the sidelines.”

Financial markets beyond stocks also reflected growing anxiety. Commodities like oil fell, and even gold dropped sharply in price. As investors continued to seek havens, United States bond prices soared for a fifth consecutive trading session, pushing the 10-year benchmark yield to a new low of 1.72 percent.

The cost of insuring the government bonds of Western European nations against default rose to a record high. The extra yield investors demand to hold Italian government debt also rose, pointing to lingering worries about debt levels in the euro currency region. Despite steps taken last week by central banks to help banks in Europe borrow dollars, there were signs of rising borrowing costs for these institutions.

It is not only economies in the United States and Europe that are faltering. Financial markets in developing countries are showing levels of stress last seen during the financial crisis, a senior World Bank official said Thursday.

The official said that problems in the developed world increasingly were shaking the economies of developing nations, not because of a drop in trade flows or capital investment, but because a sense of gloom was spreading around the world, shaking the confidence of domestic investors.

“We are increasingly worried about the possibility of global contagion,” said the official, who shared the World Bank’s assessment of the global situation on condition of anonymity.

“At some point the global mood changes. Just like the realization that even big banks are vulnerable” shook world markets in 2008, the official said, “the idea that even the U.S. is vulnerable means that many investors have lost an anchor.”

The market downturn was set in motion on Wednesday after the Fed announced that a complete economic recovery was still years away, adding that the United States economy has “significant downside risks to the economic outlook, including strains in global financial markets.”

The Fed also announced it would buy long-term Treasury bonds and sell short-term bonds to help stimulate lending and growth.

Some analysts were disappointed the Fed did not act more forcefully and they had little faith that policy tools like lower interest rates were encouraging consumers and businesses to spend more or to start creating jobs.

“The initial and follow-up reaction from the equity market is likely the realization that the Fed has little left to offer, that Washington is a mess, and their only hope is to ‘ride it out’ over a long period of time,” said Kevin H. Giddis, the executive managing director and president for fixed-income capital markets at Morgan Keegan Company. The policy conundrum is illustrated by the fact that despite lower rates people are not taking up new mortgages or refinancing existing ones. Rates on 30-year fixed mortgages dropped after the Fed’s announcement, falling to 4.05 percent from 4.21 percent on Wednesday, according to HSH.com, which publishes mortgage and consumer loan information.

But the number of new mortgage applications is running at the lowest level since August 1995, according to the Mortgage Bankers Association. Guy Cecala of Inside Mortgage Finance, which monitors mortgage activity, said the volume of new mortgages this year would probably be about $1 trillion, down from $1.5 trillion in 2011, which was already anemic.

Companies, too, are holding back on spending even though they have built cash reserves to 6 percent of their total assets, the highest level since at least 1952, according to Credit Suisse.

The proportion of United States companies’ cash flow being spent on new equipment and other investments has not rebounded since the financial crisis and is stuck at the lowest level since the late 1950s, said Doug Cliggott, an analyst at Credit Suisse. A survey by the bank of 60 large American companies published Thursday found that two-fifths actually planned to cut spending in the next six months.

In what may be a bellwether trend, FedEx, the logistics company, on Thursday cut its expectations for earnings for the entire fiscal year, citing a slowdown in global growth and sending its stock down 8 percent.

The markets on Thursday homed in on a darkening economic outlook in the euro zone and concerns that China’s growth rate would start to slow. A closely watched gauge of private sector activity from the euro zone — the composite purchasing managers’ index — fell to 49.2 points in September from 50.7 in August, according to Markit, a financial data provider.

Analysts said the fall in the euro area index reflected a combination of slowing global growth, significant belt-tightening in the euro area and growing concern about the escalating sovereign debt crisis.

A review on Thursday by Standard Poor’s showed that the market capitalization of publicly traded equities around the world had fallen by more than 17 percent, or $9.2 trillion, since July 1.

In the United States, without greater stimulus, the dollar headed sharply higher on Thursday, catching investors off guard and causing rapid selling of investment positions, like gold, that had relied on a cheaper currency.

“I think that the market had performed so bullishly across all the precious metals that a correction was probably in the offing,” said James Steel, an analyst at HSBC. “And it may have been used as a convenient place for some profit-taking.”

When the price of gold moved so quickly below $1,800, he added, it encouraged further selling. With sustained losses in stocks, investors could be using gold as it was meant to be used — to raise cash.

“This might sound perverse but gold is actually fulfilling its traditional role allowing you to raise cash in uncertain times,” Mr. Steel said.

Reporting was contributed by Matthew Saltmarsh and Binyamin Appelbaum.

Article source: http://feeds.nytimes.com/click.phdo?i=0097ecf6f2e80310a6a7698d4b4b385a

Filed Under: Business News Tagged With: , ,