A Short-Term Romance With Bonds

09/18/2007 12:00 am EST

Focus: BONDS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

Doug Fabian, editor of High Monthly Income, says buying short-term bonds is a good hedge against whatever action the Federal Reserve takes on interest rates.

It's time to get SHY again.

Of course, I am not talking about the introverted kind of shy. Rather, I am talking about adding the iShares Lehman 1-3 Year Treasury Bond exchange traded fund (AMEX: SHY) to the portfolio [ahead of this week’s Federal Open Market Committee] meeting.

This short-term bond fund seeks performance results that correspond generally to the price and yield performance of the short-term sector of the US Treasury market. SHY generally invests at least 90% of its assets in the bonds of the underlying index and at least 95% of its assets in US government bonds. Each Treasury fund also may invest up to 10% of its assets in US government bonds not included in the underlying index.

We see SHY as an alternative to the money market—an alternative that is nearly as safe as the money market and pays a better dividend yield (4.3%, according to iShares) with the possibility for capital appreciation if the bond market begins to rise. And, because it's an ETF, the expenses are low and it is much easier to trade out of than conventional bond mutual funds. (The ETF closed slightly above $81 Monday—Editor.)

We are at a very critical market juncture here, and [the Fed’s] decision on interest rates could swing the market in the direction of the bulls. Of course, if the Fed fails to give the Street what it wants to hear, we could be in for some very rough times ahead.

The point here is that you have to be prepared for anything the market throws at you—not just before the Fed meets, but at all times. One way to be prepared for whatever the market gives you is to know where the key turning points are in the market.

I suspect that the market will make a big turn either higher, or lower, depending on what comes out of the Fed’s next meeting. If the market falters on the news and starts to sell off, the key measure on the Standard & Poor’s 500 is 1440. If we pierce the 1440 mark, look out below, since it could mean a sustained move lower that could lead right into the jaws of a new bear market.

If, however, we see the market surge on the Fed's decision, the key number to look at is about 1485 on the S&P 500. If we can move above this point and sustain that move higher, it could mean the end to this summer correction and a stampeding of the bulls.
I think that if the Fed gives us an all-clear sign, we could be looking at one of the best buying opportunities in years.

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