Buying and holding Treasury bonds was a winning strategy in 2008. With 30-year bonds returning 41.3%, T-bonds were the mirror image of the stock market, which had its worst year in generations.
Thus far in 2009, however, investing heavily in T-bonds hasn't saved anyone's portfolio.
Outlook for bonds
The bond market is complicated and diverse. Just like the stock market, one part can rise while another is falling.
In 2008, prices of low-quality bonds -- also known as "junk" bonds – generally fell, while high-quality bonds like Treasuries rose. When investors try to avoid risk at any cost, they typically gravitate to T-bonds, some of the safest investments around.
In a deflationary environment, high-quality bonds and Treasuries do well, but they may also face substantial corrections at times. Sure enough, Treasuries are now declining, even as stocks endure similar pressure. Investors have decided that buying junk bonds at record spreads to Treasury bonds -- the difference in yield between the two investments -- is a risk worth taking at the moment.
Junk is bouncing
Risky bonds have rallied in the past two months, as measured by the performance of the iBoxx $High Yield Corporate Bond Fund (HYG). Treasuries, as measured by the Barclays 20+ Year Treasury Bond Fund
In my opinion, you can get stock-like returns from riskier bonds, given their high yields. But to manage your risk, you'll need to buy into those bonds through ETFs or mutual funds. Don't go into deep junk territory; stick with the higher-rated junk issuers, since it's unclear how long this recession will last.
One option is the aforementioned iBoxx $High Yield Corporate Bond Fund, which mainly holds BB and B issue bonds, and carries an average rating by S&P of B-. Its dividend yield is 8.5%, and while the ETF holds 53 different bond issues from many industries, the largest issue is weighted at 2.7%. This ETF is a good bet on an economic recovery, but its performance depends heavily on whether the unorthodox actions of the Federal Reserve work. If you'd like something safer, the Barclays 20+Year exchange-traded fund I mentioned above may also merit your Foolish research.
Meanwhile, in the stock market …
If January's any indication, the stock market faces a rough year ahead:
|
S&P Economic Sectors |
January 2009 Return |
2008 Return |
|---|---|---|
|
S&P 500 |
(8.57%) |
(38.49%) |
|
Energy |
(3.16%) |
(35.93%) |
|
Materials |
(7.24%) |
(47.05%) |
|
Industrials |
(12.66%) |
(41.52%) |
|
Consumer Discretionary |
(10.64%) |
(34.73%) |
|
Consumer Staples |
(7.67%) |
(17.66%) |
|
Health Care |
(1.30%) |
(24.48%) |
|
Financials |
(26.55%) |
(56.95%) |
|
Information Technology |
(3.08%) |
(43.68%) |
|
Telecommunication Services |
(11.06%) |
(33.62%) |
|
Utilities |
(0.83%) |
(31.55%) |
As of Jan. 31, 2009. Data from Standard & Poor's.
The stock market's weakness seems to come from the usual-suspect sectors -- Industrials, Financials, Consumer Discretionary, and Telecom Services -- all of which were down in double digits. In my opinion, the market will rally only when the banks stabilize.
To capitalize on that eventual rebound, I'd stick with the strong names in the sector: JPMorgan
Wells Fargo is clearly a big winner from the current mess. It boosted lending in its most recent quarter by $9.7 billion, while three of its largest competitors decreased lending by a combined $86.7 billion. Wells Fargo also maintained its dividend -- which currently stands at 7.2% -- and declared that it does not need more government funds. Some might disagree, but I think this one is a keeper.
Another emerging winner is Morgan Stanley
So far in 2009, stocks and bonds are sending conflicting messages. Stock investors are clearly worried, while bond investors' greater appetite for risk suggests hopefulness. Who do you think is right? Share your opinions in the comments section below.
More on market issues:
