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The bond market has a problem, mom-and-pop investors have piled more than $900 billion into bond funds since the 2008 financial crisis, buying stock-like shares of mutual and exchange-traded funds to gain access to infrequently-traded markets.
This flood of cash has helped cause prices to surge and yields to plunge. The problem is, what happens when rates start to rise and those same investors choose to leave as quickly as they arrived.
Some of Wall Street’s biggest banks are concerned that the withdrawal of stimulus will lead to an exodus that’ll cause credit markets to freeze up. And it will be made worse by new regulations which have forced banks to reduce their balance-sheet risk.
There’s a bigger risk “that when the the Fed starts hiking in earnest, outflows from high-yielding and less-liquid debt will lead to a free fall in prices,” JPMorgan strategists led by Jan Loeys wrote in a June 20 report. “In extremis, this could force a closing of the primary market and have serious economic impact.”
Todays Other Top Stories
LearnBonds: – Outperform the pros? Yes you can! – I have heard many pundits say that retail investors should simply invest in broad-market index funds because even top professionals in the business struggle to outperform the indices over the long run. Perhaps that is true regarding stocks. In the world of bonds, however, I think it’s quite easy to outperform the major indices over the long run.
Hometown Source: – School bonds could cost taxpayers less in Princeton. – Princeton School District officials are expecting to have good news for taxpayers when they open bond bids for the district’s upcoming $29.95 million construction project.
Digital Journal: – Fitch takes various rating actions on enhanced municipal bonds and TOBs. – Fitch Ratings has taken various conforming rating actions on enhanced municipal bonds and tender option bonds (TOBs) corresponding to actions taken on their associated enhancement providers or underlying bonds.
Cate Long: – A revolution in muniland. – In a speech last week at the Economic Club of New York, SEC Chairman Mary Jo White set out three new initiatives that will reorder the way fixed income markets serve retail investors.
Citywire: – Draghi has ‘superseded’ the Fed, says bond star Mather. – Mario Draghi’s decision to use several different stimulus tools shows how the ECB is following through on its commitment to revive the eurozone region.
The News Tribune: – How long will bondholders take disappointing returns? – There’s an old saying that the stock market can remain irrational longer than investors can remain solvent. But when it comes to the bond market and dealing with interest rates, solvency isn’t the issue.
Peter Schiff: – The bond trap. – The bond market is overpriced, the Fed wants to erect barriers to exit, the exit will turn into a stampede.
Fox Business: – Why a surprise rise in rates is a big risk for bond investors. – Popular opinion holds that interest rates will stay at rock bottom levels for an extended period of time, but I am persuaded that an unexpected rise in rates is the overarching risk for bond portfolios at the present time. It’s going to happen sometime, and it appears that complacency, a contrary indicator, has firmly taken hold. The time to prepare a portfolio for rising rates is before it begins to happen.
WSJ: – Treasury bonds trim price gains after U.S. data. – Treasury bonds gave up most of their price strength Tuesday as the latest releases pointed to an improving U.S. economy after the soft path earlier this year.
About.com: – Will the United States’ massive debt ever matter for U.S. Treasuries? – All else equal, a country or corporation with debt increasing at this rate would see its bonds suffer in price and rise in yield. With the United States, however, this hasn’t been the case. Even as the national debt has risen, its bond yields have fallen. The question, then, is why this is the case. And is there ever a point at which the United States’ debt burden will matter for the Treasury market?
Investment Grade Bonds
Barron’s: – Yield gap between high yield, high grade bonds approaching record low. – Corporate bond risk premiums keep grinding tighter and have hit fresh post-crisis lows yet again. The average junk bond yields just 4.86%, according to a benchmark Bank of America Merrill Lynch index, continuing that market’s recent habit of setting new all-time yield lows pretty much every day.
High Yield Bonds
MoneyBeat: – Tired of paltry junk-bond yields? Try these alternatives. – Junks bond yields these days are about equal to what a one-year Treasury bill used to fetch back in the old days (really, it’s a fact). So if junk doesn’t present the same rewards it used to, where should a yield-seeking investor go? Barron’s Jack Hough dropped by the MoneyBeat desk with some ideas for dividend-paying stocks that have growth potential and work as viable alternatives to junk bonds.
USA Today: – Junk bond yields at new and terrifying lows. – Yields on high-yield, high-risk junk bonds are at record lows, at least on a monthly basis — an area that Moody’s economist John Lonski calls “terra incognita.” If you’re an investor, that’s not a good place to be.
PIMCO: – The evolution and future of emerging markets fixed income. – As the emerging markets (EM) fixed income asset class evolves, investors want to know which trends are lasting and which are fleeting. To that end, looking at the major inflection points over the history of the asset class can provide a useful perspective. One very relevant theme that emerges is: Innovation in the EM asset class has often followed periods of global financial market volatility.
Barron’s: – PIMCO says investors underweight EM bonds, differentiation is key. – PIMCO this week published a primer on emerging-markets fixed income investing, walking through the history of the sector and offering tips on how investors should approach it now. For starters, Pimco argues most investors are underweight EM sovereign bonds.
Trading Floor: – Why I’m still bullish about EM bonds despite the risks. – There’s been a lot of talk over the past few months about emerging market bonds and whether they are a better deal than stocks. Saxo’s head of fixed income, Simon Fasdal, says he’s still bullish about them but warns that the market is exposed to geopolitical risk factors particularly Iraq and Ukraine.
Barron’s: – Best sources of income in a low-rate world. – The bond market has made a habit of defying expectations, and it has stayed true to form in 2014. The conventional wisdom was that yields would rise as the economy improved and as the Federal Reserve scaled back its bond-buying program. Instead, rates have fallen. That’s good news for bondholders, but frustrating to income-hungry investors, especially those who continue to expect rates to rise.
24/7 Wall Street: – UBS top high-yielding income ideas for the rest of 2014. – A new research report from UBS takes a broad look across all asset classes the analysts cover, looking for the best current income ideas. We highlight and update some their top picks by asset class.
ETF.com: – New active ETF planned. – Wells Fargo is the latest bank outside of the ETF space to file for permission to launch its own brand of active ETFs, continuing a trend of mutual-fund-focused firms looking to get a piece of the growing ETF market.
ETF.com: – 4 income ETFs that hit $1B in 2014. – Four ETFs, all of them income-oriented, have crossed the $1 billion threshold in assets under management in the past few months, as investors continue to look for ways to gather hefty dividends and cut attractive coupons in an ongoing era of ultra-low interest rates.
ETF Trends: – WisdomTree: Where in the world does your U.S. bond ETF invest? – For most fixed income investors today, corporate bonds may represent a significant portion of their core bond portfolios. As exchange-traded funds (ETFs) have grown in popularity over the last decade, index-based corporate bond ETFs have become a popular means of obtaining exposure to the asset class.
Gross: Are there “New Neutrals” in credit, volatility, and equity risk premiums? PIMCO is exploring.
— PIMCO (@PIMCO) June 24, 2014
We saw last summer that bulge bracket firms weren’t even willing to bid AAA munis during a few days of “taper tantrum”
— David Schawel (@DavidSchawel) June 24, 2014
MA rule ‘real game-changer’ for investment bankers in approach to muni clients; deliberately so, says Lamont’s Bob Lamb: #BBNW
— Rich Saskal (@RichSaskal) June 24, 2014