Monday, December 6, 2010

As Bonds Flag, Stocks Beckon

As Bonds Flag, Stocks Beckon


After a stellar two-year run, the bond market is stumbling and a number of investors are betting that stocks will post better returns in the coming months.

Among the signs being held up as evidence: Investors in the past two weeks pulled money from bond funds for the first time in almost two years, and there are indications of a growing move toward stocks.

The long string of bad headlines for bonds left the 10-year Treasury note yield above 3% on Friday for the first time since late July. Bond yields rise as prices fall. But the jobs numbers, along with nagging worries about sovereign debt in Europe, are reminders that any decline in the bond market could come as a slow leak rather than a loud burst—if it happens at all.

"Right now we're still in a bull market that's very tired and at risk, but hasn't started to sell off yet," said Howard Simons, bond-market strategist at Bianco Research in Chicago, referring to bonds. "It's fraying around the edges."

A series of surprisingly positive economic reports has raised hopes of a stronger recovery, which would mean higher interest rates and a robust stock market. Some relatively bearish economists and strategists, including those at Goldman Sachs, have recently raised their outlooks for growth and interest rates.

.Investment-grade corporate bonds in November had their worst month since February 2009, losing 0.8%, according to Barclays Capital indexes. Treasurys and high-yield bonds also took losses in their worst months since March and May, respectively. Only bank loans, which have floating rates and tend to outperform when rates are rising, had positive returns in November.

The Dow Jones Industrial Average has rallied nearly 18% since July 2, including a 2.6% gain last week, which held up despite Friday's jobs data.

Even if the much awaited shift from bonds to stocks may be less forceful than some expected, many observers still think stocks have more juice than bonds, as long as the economy keeps recovering.

"It is getting to a point where it will start to get tough for credit to outperform equities, given the low level of yields," said Ashish Shah, co-head of global credit investment at AllianceBernstein, noting high-yield bonds yield less than 8%, near their lowest levels in decades.

Money left bond mutual funds in the two weeks through Nov. 23, according to the Investment Company Institute, the first outflows since December 2008, roughly when the bond bull market began.

Even seemingly bulletproof emerging markets have suffered bond-fund outflows for two straight weeks, according to data tracker EPFR Global.

In the U.S., the flight from bond funds was due to a stampede from municipal-bond funds, which lost nearly $7.9 billion in just two weeks, according to ICI data.

This flight from munis may be a harbinger of what is to come if the bond market finally cracks, suggests Gregory Peters, global director of fixed-income research at Morgan Stanley.

Muni funds are telling because they are magnets for mom-and-pop money, and they are particularly sensitive to increases in interest rates.

November's surge in Treasury yields helped trigger a 2% loss in munis, according to Barclays Capital indexes, as selling begat more selling among mutual-fund managers.

Still, Mr. Peters and most bond-market observers are loath to declare that a mass exodus from bonds is imminent.

Three props could support bonds for the next several months: choppy economic growth, worries about Europe, and the promise of as much as $900 billion in Treasury purchases by the Federal Reserve.

"With that combination, it's going to be hard for bond yields to move too far," said Joseph Shatz, rates strategist at Bank of America Merrill Lynch.

Meanwhile, investors are still cautious after a dismal decade for stocks. After tiptoeing back into stock funds in October and November, investors have pulled money out of stocks again in recent weeks, according to ICI data.

Some of the recent shift of retail money into bonds may be lasting, as an aging population chooses what it thinks are safer assets than stocks. Household stock ownership is still high relative to history. Pension funds are shifting more money to bonds to match long-term liabilities.

Even if rates keep trickling higher, corporate bonds could still thrive, benefiting from economic growth and the unusually clean balance sheets of many industrial companies.

"While we believe that growth is going to be better, it's going to be a volatile path," said Mr. Shah of AllianceBernstein. "And fixed income is typically a piece of the portfolio to protect you from the volatility of the equity piece."

Recent moves out of bonds likely have much to do with investors cashing in profitable investments and avoiding big new trades that could turn a good year into a bad one. Despite the pain in November, Treasurys have still returned nearly 7% this year, and high-yield bonds have returned nearly 14%.

"The inflection point is not upon us," said James Camp, managing director of fixed income at Eagle Asset Management in St. Petersburg, Fla., who oversees about $3.9 billion in fixed-income funds. He called the recent selloff a "welcome" correction after a long run.

"People have been lulled into opening up their statements month after month and seeing bonds keep going up," Mr. Camp said, "and mathematically we know that's impossible."

Write to Mark Gongloff at

1 comment:

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