Friends Don’t Let Friends Buy Bond Funds

by JR Robinson on July 11, 2013

To be clear, there is absolutely never a time when the investment markets are predictable. That said, if there has been one relative constant for the first 13 years of the new millennium, it has been that interest rates have been falling and have remained low for several years. This low rate environment has been artificially supported by Federal Reserve policy makers attempting to foster economic growth in the wake of 2008-2009 financial meltdown. To be sure, the Fed’s loose money policy has worked – at least over the short term. Low interest rates have dramatically lowered the cost to finance a home and have made it similarly made it inexpensive for companies to borrow to finance growth (or refinance burdensome high interest rate debt).

While many prognosticators were convinced that the historic rock bottom interest rate levels could be sustained indefinitely, make no mistake, the trend has broken – interest rates have bottomed and have begun to rise. On May 22, the Fed signaled its intention to scale back its bond purchasing programs, which had suppressed bond yields and bolstered the stock market. This announcement sparked an immediate selloff in bonds and led to a sharp increase both bond yields and mortgage rates over the ensuing six weeks. For bond investors, the implications are clear as illustrated by the fact that $80 billion fled in panic from bond funds in the month of June (Source:CNBC).

Because interest rates have not risen significantly for a very long time, some investors have the decidedly misguided perception that bonds and bond funds are both safe and stable. Make no mistake, bond values decline when interest rates rise. As I have been chirping for some time now, I cannot think of a worse environment to invest in bonds. While I firmly believe there will be a time when bonds are attractive again and that it makes sense to resume building laddered bond portfolios, that time is not now.

As for the impact of rising interest rates on stocks, your guess is as good as mine. The Fed’s May announcement did trigger a mini sell-off in the stock market, but thus far the perception seems to be that the market does not fear (or take seriously) a modest rise in interest rates over the near term. Although it does not seem to me that stock market is extraordinarily cheap at this time either, I continue to favor select “rising dividend” stocks as a reasonable place to allocate money beyond just parking it in cash.

Benchmark Returns Through 6/30/2013 (Source:  Black Diamond Performance Reporting)

Benchmark Returns Through 6/30/2013 (Source:  Black Diamond Performance Reporting)

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