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Howard Gold
Jan. 28, 2011, 12:01 a.m. EST
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By Howard Gold
NEW YORK (MarketWatch) "” The past two years have seen the biggest boom in bond investing on record. Investors, fleeing the ravaged stock market, have poured hundreds of billions of dollars into the presumed safety of bond funds.
From January 2009, we saw 22 consecutive months of inflows into bond funds, according to the Investment Company Institute, an astonishing $643.4 billion in all.
But starting in November, nervous investors began to pull money from bonds "” mostly municipals, amid fears about state and local governments' finances. Outflows from munis have persisted into January, but money has continued to trickle into corporate bonds, the mainstay of the 2009-2010 bond boom.
And now many investors who've just made a big bet on fixed income are worried about getting caught on the wrong side of the trade yet again.
There are a few reasons investors might be wary of the Treasury market, says Brett Arends.
The rumblings apparently got loud enough that Gus Sauter, chief investment officer of The Vanguard Group, the largest U.S. bond mutual fund manager with $413.6 billion of fixed income assets as of Dec. 31, posted a cautionary message on the company's website.
"I'm increasingly worried that people aren't aware of the risks in the bond market," he wrote. "The problem is that when you're at historically low rates, as we are now "¦ yields aren't likely to go significantly lower, and at some point when the economy does strengthen, they're likely to push higher."
"If rates move sharply, we could experience a year or more where investors receive a meaningfully negative total return from bonds. That's certainly happened in the past. And it's very possible, if not probable, at some point in the future," he concluded. Read Pamela and Mary Anne Aden's views on the direction of interest rates on MoneyShow.com.
Vanguard was at pains to call that "education," not the dreaded "market timing." But the message couldn't be clearer: Fasten your seat belts; it's going to be a bumpy ride.
And it's a ride for which bond investors simply aren't prepared.
"Surveys have shown that many bond investors do not understand that "¦ if you have a long-maturity bond and rates increase, then prices fall," said long-time bond investor Richard Band, who edits the Profitable Investing newsletter.
Investors have moved en masse out of stocks, whose risks were amply demonstrated in the 2008-2009 market meltdown, and toward the boring, regular coupon payments of bonds. Now, Sauter and others warn that the modest returns they were counting on may not be in the bag, either.
This shouldn't be surprising, given the huge run we've seen. Still, Francis M. Kinniry Jr., a principal in Vanguard Investment Strategy Group, told me he doesn't "believe at all there is a bubble in bonds. We do not see a [popping or a bursting] in fixed income."
According to Vanguard's research, "the worst 12-month return for U.S. bonds since 1926 was [negative] 9.2%, while the worst 12-month return for U.S. stocks was [negative] 67.6%...The worst calendar year for the broad bond market was 1994, when due to an unexpected [rise] in interest rates, the bond market returned [negative] 2.9%."
So, the worst decline we've seen in bonds was chump change compared with the shellacking we've just experienced in stocks. And he adds that historically "a 3.5% bond is fairly valued." That's about where 10-year Treasury notes are trading now.
Of course, it's often hard to identify a bubble before it bursts. But the herd mentality of buying bonds, the certainty among so many investors that they were safe (remember "home prices have never fallen" or "the Internet will change everything"?), and the sheer volume of the money make me think it was indeed a bubble, albeit one of the quieter ones we've seen.
Energy-poor Egypt is a transit choke point that has oil traders fretting over regional implications of Arab unrest.
4:30 p.m. Jan. 28, 2011
"Egypt's Mubarak dissolves government http://on.mktw.net/eMRh65" 6:10 p.m. EST, Jan. 28, 2011 from MarketWatch
"Chevron posts 71% jump in quarterly earnings http://bit.ly/gBX1Ak" 5:38 p.m. EST, Jan. 28, 2011 from MarketWatch
"Dow ends day down 166 points, breaks 8-week streak of gains; traders focus on Egypt unrest http://on.mktw.net/ekkK9b" 4:06 p.m. EST, Jan. 28, 2011 from MarketWatch
"TAXWATCH: #Tax changes to watch for on your 2010 return http://bit.ly/eerelT" 3:17 p.m. EST, Jan. 28, 2011 from MarketWatch
"GDP accelerates to 3.2% rate in fourth quarter http://bit.ly/fybb1k" 2:38 p.m. EST, Jan. 28, 2011 from MarketWatch
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