Is There Value In Bonds Today?
The word “value” is oft-used vernacular in the investment world, yet in reality it is a somewhat ambiguous term. Sometimes one may think they are getting a good investment deal when in fact they aren’t. Other times it may take much longer than expected to realize value – if it ever occurs.
We usually hear the word value associated with stocks. A strategist may say on CNBC that there is “tremendous value in XYZ stock.” The connotation is that XYZ’s market price is too low given the forward earnings stream, tangible assets, or other positive attributes of the company. Whether we can say, in hindsight, that the strategist is right or not is totally dependent on whether other investors ultimately see value, of course.
To see a list of high yielding CDs go here.
So if a “value” stock drops 10% from the price in which a strategist originally termed it a value, has it become a better value? Or was this a value stock that might have been better termed a “value trap,” a security that looked like a good on the surface, but, ultimately, was cheap for a reason? A rhetorical question, but you get the idea.
Migrating over to bonds, today, especially, we seldom hear the word value uttered in conjunction with the fixed-income market given historically low coupon rates. However, while the light at the end of the “ZIRP (zero interest rate) tunnel” finally seems to be seen, bond investors have exhibited renewed buy pressure this year, somewhat surprisingly driving longer-term rates significantly lower. With 10-Year Treasury rates hovering near 3% on January 1, we find ourselves in sight of 2 percent as we enter the year’s final month. Many were expecting a move towards 4% during 2014. Ergo, there was indeed plenty of value in buying the long end of the curve at the beginning of the year.
While this year’s bond action may be interpreted in a variety of ways, it seems to me that we are being told that the domestic economy is not robust enough to tolerate higher interest rates, which could be indicative of continued bond value. Noted bond manager Jeff Gundlach was quoted in mass media this week saying:
“The Fed should not be raising interest rates, and yet they don’t want to be at zero. They’re in a conundrum…….They might raise rates just to see what happens.”
Though Gundlach is certainly correct that the Fed is in somewhat of a predicament, let’s hope central bankers don’t succumb to “just because” monetary policy. In any case, bond investors are to an extent exposed to decisions emanating out of Washington. If the Fed makes one or more moves on the short-end in 2015, it is likely that long rates will start to creep up – perhaps more than just creep up – posing renewed danger for the fixed-income market.
However 2015 shakes out, in a general sense, I think there is always value in the bond market. If one cares to lock in money at a specified rate of interest for a specified rate of time with a specified borrower, there is ample flexibility to do so. Either you are accepting of current rates of return or you aren’t. The popular consensus over the past 5 years or so has been to avoid bonds since rates are headed higher. Rates obviously haven’t headed higher, so there’s been tremendous opportunity cost for having sat on the sidelines waiting.
Their inherent value, however, is predicated on understanding the various risks involved. What happens to the interim value of a 30-year or 5-year bond if rates move much higher than anticipated? What happens if the municipality I invest in files for bankruptcy? Why is a bond’s duration an important point of information?
If you don’t understand the downside risks, there can be no upside value to owning them.
About the author: Adam Aloisi has over two decades of experience investing in equities, bonds, and real estate. He has worked as an analyst/journalist with SageOnline Inc., Multex.com, and Reuters and has been a contributor to SeekingAlpha for better than two years. He resides in Pennsylvania with his wife and two children. In his free time you may find him discussing politics, playing golf, browsing antique shops, or traveling.