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Posted by on Nov 16, 2016 in ETF Strategist, Market Insight

It’s Getting Real In The Fixed Income Market

It’s Getting Real In The Fixed Income Market

By Roger Nusbaum, AdvisorShares ETF Strategist

The title of this post is a nod to a funny rap video from a few years ago called It’s Getting Real In The Whole Foods Parking Lot.

The current issue of Barron’s has 12 articles with the word Trump, or some version of it, in the headline and just about every other article mentioned him as well. The campaign was difficult to endure, regardless of your politics and while I think most are glad it is over, the post-election period has been difficult for the country as a whole, again, regardless of your politics.

It has also been difficult for the bond markets. In this week’s Market Update for Alpha Baskets I addressed the bond market as follows;

Perhaps more interesting than the reaction in the stock market has been the carnage in the bond market. You likely heard that $1 trillion in bond market assets had been wiped out during the week but the selloff had been going on for several weeks. Since the start of October, the Ten Year US Treasury Note has gone from 1.60% to 2.11% at Thursday’s close (there was no trading Friday for Veterans Day). For some context to the impact on certain bond funds, a popular longer dated treasury bond ETF is down more than 10% since the start of October and an ETF tracking 25 year zero coupon bonds, probably the most volatile way to access the treasury market, is down 16%. The logic behind the huge jump in yields is that if President Trump implements all or even some of his policies it would be inflationary.

Barron’s had an article offering ideas for how to position as rates might be rising along with a visit with Jeff Gundlach who believes the ten year treasury is headed toward 6%, albeit not in a straight line. When these sorts of bond market flare ups occur I usually advise looking at how various bond market sectors performed in past periods of stress with the easiest examples being May and June of 2013 and before that, June of 2003. The last month and half will be another one of those microcosms. There isn’t necessarily any predictive value but it creates context for how much and how quickly a closed end fund (for example) can decline as well as the two mentioned above and any other segment that takes on relatively high volatility potential.

Banging the same drum as before, when the big one for rates comes, whether that is now or in the future, there will be income market segments that will be the wrong thing to own like having a 40% weight to tech when it comprised 30% of the S&P 500 right before the bubble popped.

The parts of the income market that should be relatively safe to own have in fact been relatively safe as rates have been rising over the last six weeks. High yield tends to be far less interest rate sensitive because the duration tends to be short and the yield is thought to offer a cushion against rising rates in lower yielding segments. Bank loan funds have done well through this because their interest rate resets every 90 days. Short dated paper is doing well because it will pay out at par so soon. Gundlach likes TIPS and while there are short dated TIPS and TIPS funds available, even longer dated TIPS funds are holding in just fine

If you’re an investor, you need yield and if you’re an advisor your clients need yield. There is yield to be had without taking the obvious risk which is now interest rate risk. I would tell people not to spend a lot of time worrying about a repeat of 2008 when income markets had all sorts of problems (commercial paper stopped working, auction rate preferred stopped working) related to liquidity drying up. There could easily be another huge income market malfunction but if there is, it won’t be 2008’s breakdown, that already happened, it will be something else.