Bond Market Outlook 2014

January 1st, 2014 by

Bond Market Outlook 2014The past year has proven a difficult one for bond buyers and holders. With the benchmark ten-year treasury having started the year below 2% and progressed its way to around 3%, any bond purchase with sizable maturity made over the past 18 months is likely sitting in the red. The Fed’s hint at a bond buying taper back in May, which initially spooked interest rate sensitive securities, including bonds, finally became reality two weeks ago with monetary policymakers saying they would ease economic stimulating bond purchases from $85 billion to $75 billion a month starting in January.

 

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While the announcement of the slightly better than 10% taper seemed to relieve the equity market with stocks rallying, long-term rates have creeped higher as fixed-income investors appear to see an ultimate end to ZIRP (zero interest rate policy) that has enveloped the short-end for the past four years.

Due to the inverse relationship between interest rates and bond prices, the fear and reality of persistent rising rates on both the short- and long-end is a concerning development for fixed-income investors. Though the common perception today is that the Fed will “have” to tighten rates at some point in the future, we still have no visibility as to when or even if that will occur.

Indeed, the next year will likely be a “taper and let’s wait and see period” for the domestic economy. If the taper, however aggressively it is implemented, proves to be a non-event, then we could certainly see long-rates move even higher (and bond prices lower) during the course of 2014, with the reality of Fed tightening becoming imminent. On the other hand if we see a GDP hiccup, the taper would likely be suspended, and rates could potentially move lower, as the Fed plots its next move and investors attempt to decipher the implications.

Thus bond market action next year will be predicated on and all about the economy’s reaction to the taper. I personally see this as a flip of the coin situation that no one in reality can accurately predict, thus I would continue to advocate a close-to-the-vest positioning for bond investors. This would include investment in short maturities, unless you are desperate for yield and are not overly concerned with interim capital destruction or opportunity cost. The rewards on the yield curve are not there, in my opinion, to justify buying multi-decade paper.

And even though junk debt defaults remain on the low side, I would try to keep credit as solid as possible. This is not to say that those with the tolerance to do so should not venture responsibly into below investment grade paper. However, the uncertainties regarding the taper and some of the conflicting economic data of today suggest, in my opinion, a non-aggressive approach towards credit quality.

One of my specific value recommendations for more aggressive bond investors is to take a look at a number of closed-end funds trading at drastic discounts to net asset value on the open market. Western Asset High Yield Opportunities (HYI), although it focuses on the lower end of junk is a non-levered CEF with short duration, a high level of diversification, and a lofty yield. I also like AllianceBernstein Global High-Income (AWF), which trades at a much narrower discount, but has a good track record.

Conclusion

Though the mystery behind the introduction of the so called Fed taper is behind us, the bond market in 2014 will continue to focus on economic cues and language from Central bank policymakers. Aggressive bond investors with a specific inclination on the direction of the taper and long-end interest rate movements may want to make some calculated bets. More conservative players with an agnostic take on economic progression may be well advised to continue on a more controlled path with short maturities and near-investment-grade credit to protect against the taper’s unknown consequences.

About the author:

aloisiAdam 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.

 

 

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