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Don’t Panic: How to Avoid a Bond Crash

By Richard Stavros on November 3, 2016

Investors should trim bond portfolios, lock in some gains, and generally brace for more bond declines. Bond selling is on the rise, and many are calling  for the end of the 35-year bull market in bonds this year.  

Behind the bond selling: An expected Fed rate increase in December, rising inflation worries, end of central bank stimulus programs. That’s meant bonds of all stripes are taking a licking, from investment grade, to sovereign  to junk bonds.

The Wall Street Journal reported that the biggest high-yield bond ETF (HYG), had its worst month since January. The biggest high-grade bond ETF (LQD), had its worst month since June 2015.

Meanwhile, J.P. Morgan reports country (sovereign) bonds have had the biggest drop in monthly total returns since May 2013. Here at home, in the last week, the U.S. 10-year benchmark climbed to a high of 1.87% (bond prices move inversely to yields) a level not seen since early June, as U.S. GDP grew a strong 2.9% in the third quarter, increasing December Fed rate increase expectations.    

Cash is King

No one knows for sure that bonds will continue their declines into the next year, but there is enough uncertainty that even the big money fund managers are being more cautious and keeping more of their portfolios in cash.

Fund managers increased their cash balances to 5.8% of their portfolios in October, up from 5.5% the month before, matching levels not seen since the aftermath of the Brexit vote, according to a Bloomberg report. In fact, the share of cash hasn’t been this high since November 2001, shortly after the 9-11 terrorist attacks. 

Further, the Bank of America Merrill Lynch monthly survey of money managers found there hasn’t been this much cash in portfolios since during both Europe’s sovereign debt crises and the U.S. debt ceiling debacle.  Said Michael Hartnett, the bank’s chief investment strategist: “This month’s cash levels indicate that investors are bearish, with fears of an EU breakup, a bond crash and Republicans winning the White House jangling nerves.”

Hate to Say We Told You So …

Only a few months ago, when we last reported on the bond bubble in a story, Bonds, Bubbles, and Miami Vice, the idea of a bond bubble bursting in a span of just a few months seemed more remote as investors continued to ignore the signs.

Back then we also advised investors to trim their bond portfolios, particularly those bonds that have gained in the recent bull market but offer yields that are too low to offset any major loss of principal. And we advised investors to trim bonds considered high risk, such as high yield or “junk” bonds. We continue to stand by this advice, and we feel even more strongly about it considering that this week oil prices continued their decline.  Data showed the biggest weekly U.S. crude surplus on record: U.S. crude futures fell $1.33, or 2.9%, to $45.34 a barrel on the New York Mercantile Exchange

there is always the possibility that global economic growth could again weaken, the Fed may not raise rates and central banks will continue to stimulate, which would keep rates low and bond prices humming.

But we believe it pays to be cautious, particularly when the entire world seems to be on heightened alert to the possibility of a bond crash.    

 

 


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