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Robert Powell's Your Portfolio
April 27, 2011, 12:01 a.m. EDT
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By Robert Powell, MarketWatch
BOSTON (MarketWatch) "” All across America, investors are talking about one thing and it's not the royal wedding. It has to do with the Federal Reserve, and the topic is this: What sort of opportunities might arise or disappear after Quantitative Easing II, or QE2, ends in June?
It's a good question and one that's been discussed "internally here for some time," said Larry Whistler, a CFA charterholder and president and chief investment officer of Nottingham Advisors.
"The short answer," he said, "is I'm not sure investors should be doing anything differently because of the imminent end of QE2."
Plenty of professional investors "” including Bill Gross, co-chief investment officer of PIMCO; Jeff Gundlach, manager of DoubleLine Total Return Fund /quotes/comstock/10r!dbltx DBLTX +0.18% ; and Rick Rieder, chief investment officer of fixed income, fundamental portfolios for BlackRock "” are reportedly lined up on opposite sides of the trade. Strategas Research Partners recently noted that the Fed has purchased 70% of Treasury debt since November.
But that does prompt the question: Who will fill the void when the Fed stops buying bonds? "The answer, I believe, is the domestic investor, only at much higher rates," Whistler said. For his part, Whistler predicts that the 10-year U.S. Treasury will yield 4%-plus by midsummer. It's now trading at 3.3%-ish.
Of course, there's another view. "The opposite argument is that the end of Fed buying will cause the economic recovery to lose steam, the stock market to fall "” and interest rates to remain low because of that," Whistler said. "I understand that argument but don't subscribe to the theory."
Given the possibility that interest rates rise over the course of the summer, what should you do? "As with most things, it probably pays to hedge your bets while avoiding any radical moves that could prove costly if you're wrong," Whistler said.
With respect to Treasurys, Whistler suggests shortening your durations to avoid the risk of principal loss if rates rise. "For fixed-income investors, the trade-off right now is income versus principal protection," he said. "A duration inside three years will help you protect principal but will produce very little income."
Given the rock-and-hard place that many fixed-income investors are in, he said that one "hedge" strategy to consider is this: Construct a barbell, buying one-to-three-year maturities and seven-to-10-year maturities. "The yield curve is very steep so you are getting paid to move out a bit," he said. "That said, by leaving some money short-term, investors can take advantage of higher rates when they materialize."
As for investment ideas, Whistler is fond of investment-grade corporate bonds over Treasurys right now. For investors with less than $100,000 to invest, he suggested constructing a barbell with ETFs, buying iShares Barclays 1-3 Year Credit Bond Fund ETF /quotes/comstock/13*!csj/quotes/nls/csj CSJ +0.16% and/or the iShares Lehman 1-3 Year Treasury Bond /quotes/comstock/13*!shy/quotes/nls/shy SHY +0.10% on the short-end, and iShares IBoxx $ Investment Grade Corporate Bond fund /quotes/comstock/13*!lqd/quotes/nls/lqd LQD +0.47% or the PowerShares Build America Bond Portfolio /quotes/comstock/13*!bab/quotes/nls/bab BAB +0.74% on the long end.
As for municipal bonds, Whistler said, "they've already been hammered due to uncertainties and fears surrounding the creditworthiness of state and local governments."
But his best guess is that a sell-off in Treasurys might be slightly more muted for municipal bonds and that the "ratios may simply adjust closer to historical norms." Historically, 10-year municipal bonds yield about 85% of Treasurys and 30-year municipal bonds yield 92%. Right now, both 10-year and 30-year municipal bonds can be had at 100%-plus of Treasury yields, he said.
When it comes to investment ideas for municipal bonds, Whistler recommends sticking with "very high-quality essential-service bonds or strong state general-obligation bonds. And he prefers "defensive structures" that mature in 10 to 15 years but are callable in four to six years. "You get a little higher yield in exchange for selling the call option to the issuer and if rates rise, you benefit with a higher yield to maturity than a straight non-callable bond," Whistler said. He suggested avoiding states such as Illinois, Nevada and California "as fiscal uncertainty outweighs incremental yield at this point."
Plus, he advised against buying "insurance" on bonds and he advised against buying municipal ETFs "because the tracking error is too high."
With a jump in operating costs, Amazon.com had a big Q1 earnings miss, but Wall Street doesn't obsess about it too much as its revenue hits new heights
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