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Bonds: Different Strategies for a Common Goal


Skip long-term treasuries and buy more stocks: That’s the sentiment (and title) behind an article by Forbes on September 27.

Forbes reported news of the Federal Reserve voting “to revive a half-century-old procedure to push down long-term interest rates and make it cheaper for businesses, municipalities and consumers to borrow funds… [by directing] $400 billion from the sale of short-term Treasury and invest it in those with maturities of six to 30 years.”

Furthermore, the article indicated that the decision was made when the yield for the S&P 500 exceeded that of the 10-year Treasury bond. At the time of the article, by the end of closing week September 30th, the 10-year T-bond was 2.23% and the S&P 500 yield was 4.35%. The significance of this (or the good news) is that the S&P 500 yield has only exceeded the bond yield 20 times since 1953 on a quarterly basis, according to Sam Stovall of Standard & Poor’s, the article added. The bad news is that this happened when the US government’s credit rating dropped for the first time since regulatory demand began in the 1930s and now investors are dumping government bonds- once the safest form of risk- like last year’s Netflix envelops.

Several factors that have stifled the economy continue to affect the overall health of the bond market in relation to how investors weight their portfolio.

“Information [retrieved from Trading Economics, October 7] received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.”

Now more than ever, bond diversification is the key to portfolio sustainability.

However, a rather big contradiction in terms is developing. Between September 18 and October 6, investment firms of the likes of Morgan Stanley Smith Barney, Wells Fargo Advisors and UBS have since “scaled back their portfolios’ exposure to equities…, shifting away from stocks and into fixed income and cash,” as reported by Reuters October 11; contradicting the previously stated notion of selling off bonds and purchasing stocks instead. Although, it is important to note that brokerage firms are accounting for government bonds only, as opposed to other types of bonds, and economic recovery on a global scale.

On October 10, the S&P 500 Index had its biggest rally in nearly six weeks and had gained 8.8% from its previous six trading days. “Despite [the stock rally], investment officers at [these] firms say they don’t believe governments in Europe and the U.S. are doing enough to address the crushing debt undermining their financial systems. Investment managers said they believe the ongoing uncertainty and wild market swings are here to stay,” according to the report.

These actions from the investment companies came before the Fed conducted its first $400 billion bond swap, dubbed “Operation Twist,” as the Fed will sell an equal amount of maturities of 3 years or less. The purchases in all would be completed by the end of June 2012, both statements gathered by MarketWatch. The initial permanent open market operations ‘twist’, as stated by Briefing.com, was held on October 3 with the Fed purchasing $2.5 B worth of 2036-2041 and later making subsequent purchases of $1.72 B worth of 2021-2031 maturities and $2.50 B worth of 2036-2041 maturities on October 7 and 18, respectively.

The opposing views lead us to the question: As an investor, what to do? Follow the national news junket for investment strategies or the movements of money managers?

Stock market indicators, the SPX Index and NYMO Index, show that short-term stocks are currently being overbought although the uptrend for buyers could be reaching exhaustion. Jeffrey Saut of Raymond James Financial posed on October 24 in his Investment Strategy commentary titled “Got Jobs?!,” that “over the past two weeks the SPX has rallied more than 10%, yet investors have “pulled” some $11 billion from equity mutual funds. That’s the highest two-week total since early August when the stock market was in a free-fall.” He goes on to declare,

“Given those parameters [the October 4th intraday low of 1074.77 and the May 2nd intraday high of 1370.58] how should investors, and traders, position themselves into year-end? Well, traders should have raised stop-loss points on their remaining “long” trading positions because of the short-term overbought condition. That said, overbought markets can stay overbought for longer than most expect. Investors, on the other hand, should continue to accumulate favorable stocks during periods of weakness.”

There is the key phrase- periods of weakness- investors typically bail out when there are signs of market struggle even though there are companies out there with strong earnings; however, Jeffery Saut suggests that investors should do the exact opposite because “even a marginal shift in asset allocations to out of bonds and into stocks could cause stocks to trade higher than most expect.” And as we all know as volatility decreases, the market strengthens generating higher returns. Saut also stated,

“Indeed, professional money is profoundly underinvested. For example, a few months ago I made my annual sojourn to Europe to speak with institutional accounts. In seeing more than 100 portfolio managers (PMs) I could not find one that had more than a 15% weighting in U.S. equities despite the fact those PMs’ performance benchmark, the MSCI World Index, has a ~43% weighting in U.S. stocks. Yet, it is not just the Europeans that are light [in] U.S. stocks. Here in our country endowment funds are under 10% weighted in U.S. equities. Ladies and gentlemen, there is no way an endowment fund can achieve its annual mandated return of between 6% – 9% with ~2.2%-yielding 10-year Treasury Notes!”

The underlining message here (whether investing in bonds or stocks) is that as some money managers adjust their portfolios quarterly, investors should do the same without under-weighting the portfolio.

Diversification is paramount but allocating your position too cautiously, giving earnings are “better than estimated” and could remain so for the continuing year, will only hinder more potential return.


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