Investor 007's Bond Dossier

Meet Investor 007. His specialty? Bonds. Fixed-income bonds.

Don't be fooled by their low-profile reputation. Beneath that cunning disguise, bonds are sophisticated tools to help safeguard your portfolio from the perils of riskier investments. Here's the latest intelligence on their high-stakes world. If you're new to the game, get briefed on the basics of Investor 007's business, or check out our Bond Center for useful gadgets to help ensure a successful investing mission.

Spying on rates
The benchmark U.S. Treasuries are key rates to keep under surveillance. Corporate issues are generally priced at a spread to a Treasury rate with a similar term, based on the issuer's credit rating.

Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Last week, Treasury prices fell for the fifth consecutive week, registering their largest weekly decline in more than a year. Soaring bond yields drew blame for a tumble in equity prices as accelerating global economic growth made many worry that the Fed may soon raise interest rates. For the week, the two-year note yield gained 3 basis points to 4.99%, while the benchmark 10-year yield increased 16 basis points to 5.11%, and the 30-year yield surged 19 basis points to 5.21%. Bond prices move inversely to yields.

Treasuries started the week on a positive note Monday, when bargain hunters stepped in to take advantage of the market's recent freefall. During a day of little data and another slump in Chinese equities, the 10-year yield rose more than 2 basis points to 4.93%.

On Tuesday, unexpected strength in the services sector and weakness in foreign government bonds pushed prices down, and the two-year and 10-year reached their highest yields since August.

Prices recovered on Wednesday. High yields drew equity investors into the bond arena despite evidence of inflationary pressure on labor costs and a rate hike from the European Central Bank. The yield curve righted itself as the two-year note yield dropped to 4.95% and the 10-year yield slipped to 4.97%.

Then came Thursday, the bond market's worst day in more than three years. A hike in the New Zealand interest rate, a surge in global bond yields, and technical-induced selling from mortgage players exacerbated selling pressures. The yield curve steepened further as the 10-year yield rose 19 basis points to 5.16%, while the two-year yield rose to 5.04% and the 30-year bond yielded 5.25%. Prices recovered a bit from late-session buying Friday, as prices received support from a narrowed trade deficit and participants reconsidered whether the market was oversold.

Detecting developments
Investor 007 noted the following occurrences in the bond market last week:

• Both Goldman Sachs (NYSE:GS) and Merrill Lynch (NYSE:MER) dropped their forecasts of a rate cut this year. Goldman now predicts that by the end of this year, two-year notes will yield 5% and 10-year notes will yield 4.9%.
• Bill Gross, chief investment officer of PIMCO, opined Thursday afternoon that the 10-year Treasury yield might reach 6.5% in the next five years, contributing to further market negativity.
• Countrywide Financial (NYSE:CFC) sold $2.5 billion in notes in a two-tranche offering of five-year notes.
• Bank of America (NYSE:BAC) sold $3 billion in notes in a two-tranche offering of two-year notes.
• Genworth Financial (NYSE:GNW) sold $350 million in five-year notes.
• Georgia Power, a unit of Southern Company (NYSE:SO), sold $450 million in 10-year notes.
• ING Group (NYSE:ING) sold $1 billion in perpetual hybrid securities, increased from $300 million.
• Integra LifeSciences Holdings (NASDAQ:IART) sold $300 million of senior convertible securities in a two-tranche offering of three- and five-year notes.
• Janus Capital (NASDAQ:JNS) sold $750 million of securities in a two-tranche offering of five-and 10-year notes.
• Jefferies Group (NYSE:JEF) sold $600 million in securities in a two-tranche offering of seven-year notes and 20-year debentures.
• Reliant Energy (NYSE:RRI) sold $1.3 billion securities in a two-tranche offering of seven-year and 10-year notes, increased from $1.25 billion.
• Valero Energy (NYSE:VLO) sold $2.25 billion of debt in a two-tranche offering of 10-year notes and 30-year bonds, increased from $2 billion.
• WellPoint (NYSE:WLP) sold $1.5 billion securities in a two-tranche offering consisting of 10-year notes and 30-year bonds.

Hot tip
When people hold garage sales, they price their junk at low prices to get rid of it. In an interesting twist in the junk bond world, low yield premiums are now the current trend.

According to the high-yield index of Merrill Lynch and reported by Bloomberg, the extra yield typically demanded by investors to own junk bonds fell to a record low at the end of May. The premium averaged 2.42%, half of the approximate 5% average over the past five years. That means that investors aren't being compensated so well for the additional risk of holding riskier securities.

Last year, $687 billion of junk-rated loans were issued and sales approximate $474 billion so far this year. It's not likely that this pace will let up any time soon as they fuel the private-equity boom. Buyout folks like Kohlberg Kravis Roberts co-founder Henry Kravis point to low borrowing costs as keeping leveraged buyouts affordable. Some financial leaders do have concerns, though, such as Fed Reserve Chief Ben Bernanke, who is worried about lenders taking on too much risk.

Investors may also be assuming excess risk. Like any garage sale purchaser: buyer beware. While a growing economy makes it easier for issuers to meet their debt payments, it still can't provide a panacea for the financial health of all below-investment grade companies. At the end of the day, if your issuer defaults, you're left holding damaged goods. While that may be fine for Kravis, who can afford to take a knock or two, consider whether it's really OK for you -- especially when safe ol' Treasuries are offering attractive yields.

Bank of America and Southern Company are Motley Fool Income Investor recommendations. While Integra LifeSciences Holdings is a Motley Fool Stock Advisor pick. Take a 30-day free trial and see all Motley Fool recommendations.

Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since serving in banking and legal capacities covering debt underwriting as well as fixed-income derivatives. She owns U.S. Treasuries and shares of the Fidelity Inflation Protected Bond Fund and Goldman Sachs. She prefers her portfolio shaken, not stirred. The Fool has a disclosure policy.