Surviving the Bond Market Meltdown

01/05/2011 3:58 pm EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

The key for fixed income investors is keeping duration short and shunning all but the strongest credits, writes Marilyn Cohen, editor of Bond Smart Investor.

Come one; come all to the bond market selling frenzy. The clobbering the bond market is taking isn’t a surprise. We’ve bad-mouthed long-term bonds and long-term bond funds throughout 2010, begging readers to take profits and purchase three- to eight-year bond maturities.

The reflationary forces are in full swing. The impacts of the Federal Reserve’s quantitative easing are kicking in. Bonds and equities agree—Big Ben (Bernanke) is reflating our way out. Interest rates are headed higher. Bond fund redemption risk is at full throttle.

Bull markets rarely end with a whimper. They end with a BANG! Seemingly sane investments suddenly turn sour. Investors must rethink and redefine risk. Bond market volatility will soon become the angst de jour.

Bell Tolls for Baby Boomers
The seeds of economic recovery are now sown as the end of the 30-year bond bull market grows bear claws. The run-up in yields since the November elections and the announcement of quantitative easing is something bigger than a mere sell-off. Bid-wanted lists are flooding bond trading desks. The selling gains momentum—then rests—then begins again. Baby Boomers chin-deep in bond funds have never had to survive a bond bear market with their own money at risk. In the bloody bond bear market of 1994, the Boomers were merrily invested in equities.

My call to arms is to shorten your maturities now. The federal deficit as of Sept. 30 was $1.3 trillion, 9% of the US gross domestic product. The only thing Congress seems to know how to do is spend, borrow, and glom on even more debt. Unless something unforeseen happens or the Eurozone melts down, the game has changed. The old rule book won’t work.

Sticking With Fat Elvises
We need to focus on what is going right. In July I wrote about corporate balance sheets being in their Fat Elvis phase, and they've gained even more girth since. These companies have become less susceptible to problems. They are cash-rich beyond most bond investors’ imagination.

Sure, mergers and acquisitions are ramping up, but at a slower pace. These deals now use less debt to get accomplished. Today, it’s a combination of cash, equity, and some debt to fill the shortfall. That’s good news for bond investors.

Of course, corporate stock dividends are increasing too, but not to the magnitude that equity investors were praying for. Cash-rich balance sheets are still the order of the day.

Long Is Wrong
So stick with the winning trades—good quality corporates with fortress balance sheets, good management, products the public wants and unique or necessary product niches. Bond yields are what they are. Rates are in their herky-jerky phase of moving higher—much higher. If you stay at the front of the yield curve (short duration), your bond portfolio will withstand the punishment.

[In her prior excerpt Cohen recommended two corporate issues that passed her test. Also turning bearish on bonds of late have been Mary Anne and Pamela Arden as well as Doug Fabian, Roger Conrad, David Fried and Kelly Wright—Editor.]

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