Building A Bond Portfolio In a Post Taper World and Today’s Other Top Stories

December 19th, 2013 by

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Yesterdays news that the Fed will begin paring back its monthly bond buying program, starting next month, caused bonds to sell-off sharply on Thursday, with the 10-year Treasury note yield rising to 2.93%. But the most significant selling was in the five-to seven-year maturities on concerns about the Fed’s eventual plans to raise interest rates.

Theses concerns are centered on the fact that the Fed did not reduce its preferred target on the U.S. unemployment rate for when it would start raising rates. Currently that threshold is 6.5%, though outgoing Fed Chairman Ben Bernanke did mention that the threshold was not a trigger, and the Fed most probably would keep rates at the zero level long after the household rate fell below 6.5%.

So how should you structure your portfolio, given that interest rates will slowly creep up as economic conditions improve and the Fed begins to pare back more of its bond buying next year.

Wells Fargo Advisory Services Group (ASG) told Pat Mccluskey at Barron’s that, “stronger economic conditions coupled with a gradual slowing of bond purchases by the Fed should allow for somewhat higher interest rates in 2014. ASG’s expectations are that by year-end 2014 the yield on the 10-year Treasury will be 3.50% and the yield on the 30-year Treasury will be 4.50%.”

In such an environment, we continue to recommend that fixed-income investors maintain portfolios with short-duration—we favor a duration of five years, which is slightly short of the 5.5 year average duration on our benchmark, the Barclays U.S. Aggregate Bond Index. In addition, we believe that investors should maintain a diversified portfolio of investment-grade rated securities.”

 

Todays Other Top Stories

Municipal Bonds

Schroders: – 2014 Outlook: U.S. municipal bonds. – As we look forward into the year, the primary drivers for returns in the municipal market will be rising rates and spread compression, particularly in the intermediate to long end of the curve.   Negative returns due to rising rates will be somewhat mitigated by spread compression and positive carry.

Bloomberg: – Princeton university to tap muni market in $200 million sale. – Princeton University, one of the world’s wealthiest schools, plans to borrow $200 million through the municipal market in January.

Bloomberg: – KKR buying wood-pellet bonds shows high-yield lure. – A Louisiana lumber town has become the crossroads for an unusual buyer and seller in the U.S. municipal market: private-equity firm KKR & Co. (KKR) and the world’s biggest manufacturer of wood pellets.

Focus – On Funds: Taper or no, a good week for muni CEFs. – A surge in stocks, turmoil in the gold market — chalk it up to the Federal Reserve. Battered municipal-bond closed-end funds are marching to a different beat.

WSJ: – Judge urges renegotiation of Detroit debt deal. – A federal judge handling Detroit’s municipal bankruptcy on Wednesday encouraged the city of Detroit to try to renegotiate a questionable deal to restructure about $300 million in secured debt, city officials said.

 

Treasury Bonds

LearnBonds: – Should an investor be buying Treasury Inflation Protected Securities (TIPS) at this time? – Well, TIPS were created for investors that wanted to protect themselves from price inflation. By creating an instrument that protected investors from price inflation, the US Treasury Department was attempting to create an instrument that yielded what can be called a “real” interest rate.

Bloomberg: –  Treasury 10-year yields climb to 3-month high on taper prospects. – Treasury notes dropped for a second day, pushing 10-year note yields to a three-month high, on bets the Fed will conclude its bond-buying program by end of next year as it steadily reduces purchases amid economic improvement.

Reuters: – Bonds sell off after Fed taper, stocks retreat. – U.S. government bonds sold off sharply on Thursday, one day after the Federal Reserve started winding down its crisis-era stimulus, while major U.S. equity averages slipped from record levels reached in Wednesday’s post-Fed rally.

 

Investment Grade

Donald van Deventer: – General Electric Capital Corporation Bonds: Bigger is not better. – This note uses the default probabilities and bond credit spreads of General Electric Capital Corporation, the financial services subsidiary of General Electric Company (GE), to measure the reward-to-risk ratio on the company’s bonds.

 

High Yield

MarketWatch: – Babson Capital global short duration high yield fund. – Babson Capital Global Short Duration High Yield Fund (the “Fund”) BGH -0.77% announced a special dividend of $0.3105 per share payable on January 2, 2014. The Fund anticipates that this distribution will be paid from short-term and long-term capital gains. This distribution is in addition to the Fund’s regular dividend of $0.1677 per share, which is payable on January 2, 2014.

FT: – Global high-yield corporate debt booms. – Investors’ hunger for yield in a low interest rate environment has led to the best year for global high-yield corporate debt on record, according to Thomson Reuters. It has reached $473bn this year, already up 18 per cent over last year’s total.

 

Mortgage Backed Securities

Bloomberg: – Mortgage yields at three-month high on taper; Credit swaps hold. –  Yields on Fannie Mae mortgage securities that guide U.S. home-loan rates climbed to the highest in three months after the Federal Reserve said yesterday it will trim its total monthly bond purchases by $10 billion. A gauge of company credit risk was little changed.

 

Emerging Markets

Money Marketing: – David Hambidge: Emerging markets and gold are the big losers of 2013. – As 2013 draws to a close, I have to say that it has been a most fascinating year from an investment point of view.

 

Bond Funds

MarketWatch: – Money pulled from stock, bond funds in latest week. – Long-term mutual funds posted estimated outflows of $7 billion in the latest week as investors pulled money from bond and U.S. equity funds, according to the Investment Company Institute.

MarketWatch: – Resolve to raise income through bond funds. – Since the first hint that the Federal Reserve would begin tapering its monthly bond-buying program and long-term interest rates began to rise last May, investors have shunned all types of bonds and bond funds. Nowhere is the negative sentiment more evident than among closed-end bond funds. However, several factors have recently combined that may help these funds fulfill investors’ New Year’s resolutions to earn more income.

Philliy.com: – Your Money: What Fed’s bond-buying move means to an investor. – Now that the Federal Reserve has decided to cut back its bond-buying by $10 billion a month, the move could torpedo the bond market. What’s an investor to do?

Yahoo Finance: – Great expectations for investment rotation. – After years of sticking with plain-vanilla bond funds, investors are starting to turn their backs on them and opt for stocks instead. The move isn’t big enough to be the “great rotation” from bonds to stocks that many experts predicted — it’s more of a good rotation — but fund managers say more is on the way.

BusinessWeek: – Leaner times for Wall Street bond traders. – These should be good times for Wall Street bond departments. Central banks are pumping unprecedented amounts of money into the financial system to keep borrowing rates low and boost economic growth. But instead of raking in record revenue, Wall Street banks are jettisoning bond holdings and shrinking credit teams as they seek to comply with rules issued by the Basel Committee on Banking Supervision and the Dodd-Frank reforms passed by Congress in 2010.

MoneyBeat: – Fidelity: Taper doesn’t necessarily mean rates will rise. – That’s the message mom-and-pop bond investors should take from Wednesday’s announcement that the Federal Reserve will begin slowing its bond-buying stimulus program, says Ford O’Neil, who oversees the $12.5 billion Fidelity Total Bond Fund.

MoneyBeat: – BlackRock’s Rieder: Fed Statement will boost stocks, riskier bonds.  – The Federal Reserve’s decision to dial back bond buying gradually will boost demand for riskier assets including stocks and bonds outside the safe-harbor Treasury bond market, said Rick Rieder, top fund manager at BlackRock Inc BLK -0.72%, the world’s biggest money management firm.

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