5 reasons to buy bonds again

Don't worry, we aren't headed for a secular bear market in these investments. Here's why you can jump in.

By Forbes Digital Dec 24, 2013 9:51AM
Credit: © Jitalia17/Getty Images
Caption: US Savings BondsBy John S. Tobey, Forbes Contributor

Bonds in 2013 finally got their comeuppance.

After a long, pleasing ride of income plus price gains, the bond market decided the party was over. It only took four months for the 10-year U.S. Treasury note to drop the equivalent of over five years' interest. All but the shortest maturities suffered similar fates.

So why should we expect that we're safe again? Couldn't 2013's drop be the harbinger of worse to come? Like gold, mightn't we be entering a secular bear market in bonds?

Here are the five reasons why bonds can be bought now with confidence and safety:

1. What you see is what you expect
Unlike with stocks, professional bond investors are notorious for keeping an unbiased, critical eye on what's happening -- particularly what could go wrong. The reason is that bonds have a skewed return outcome -- the expected and maximum return over a bond's life are the same. Buy a bond with a 3% yield-to-maturity and hold it to maturity -- if all goes well, the return is 3%. However, let something go awry and that return is in jeopardy.

What this means is that, at any point in time, what you see is what to expect. Unlike with stocks (or gold), where previously bullish investors still hanging on could cause a further drop in price if spooked, bond investors adjust quickly to new facts and forecasts, resetting yields that fully reflect the changed environment.

2. The Fed's effect on longer yields is over and done
Yes, the Federal Reserve says its only reducing purchases slightly. However, its effect on non-short yields has always been tenuous. Past periods have shown that effectiveness, unlike with money market rates, can be close to zero.

Judging by the size of the 2013 yield adjustments, the Fed effect has mostly or completely dissipated. We can see the effect by looking at the new steepness in the yield curve. Anchored in the Fed's near-zero short-term rates, longer yields are significantly higher. In absolute terms, the new yields look appropriate to current economic/financial conditions and inflation outlook.

Want some proof? Last Tuesday, before the Fed's Wednesday release, The Wall Street Journal reported that "there is an argument to be made that it [the bond market] already has priced in the scaling back of bond purchases."

The important explanation for our use is this: "The yield on the 10-year Treasury note has risen 1.25 percentage points, to 2.877%, since taper talk began in early May. It may not go much beyond 3% for the time being." Sure enough, the Fed's Wednesday comments failed to bump yields. The stock market, happy at the bond market's steadiness, galloped ahead, in spite of the Fed's "we'll be cutting back" indication.

3. Economic measures across the board are strong
The past few weeks have been filled with significantly positive reports showing that growth has taken hold. Most importantly, this growth finally is having the natural compound effect of raising valuations, confidence and even government revenues.

For bond investors, this underlying economic health is just the thing to promote financial health and a sound bond market.

4. Bondholders now have added protection
It isn't just the new regulations and enhanced regulatory watchfulness. Nor is it the more reliable bond ratings. While those items are important, the real protection comes from Wall Street itself. Having been through such an undesirable period, business operations are both well founded and sensible. No industry-wide bubbles, over-optimism or extremism exists now. (Yes, something will happen in the future, but that's far off.)

Therefore, we can rest assured that bonds and well-managed bond funds don't have hidden risks or unrealistic expectations underlying their valuations.

5. The steeper yield curve provides added return potential
"Riding the yield curve" can be enjoyable, offering gains and protection from interest rate increases. For example, take a 10-year bond bought at a 3% yield, when 9-year bonds are at 2.9% yield. If nothing changes after a year, the bondholder has the 3% income plus the price increase that adjusts the bond to the 2.9% yield. Conversely, if rates have risen such that 9-year bonds now yield 3%, the bondholder has the 3% income without any price loss.

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23Comments
Dec 24, 2013 1:31PM
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I didn't read one word in this article that convinced me to buy bonds. If I buy today, and interest rates increase over the next few years, my principal will be lower. What kind of investment is that? 
Dec 24, 2013 12:45PM
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#1 Reason - So banks, hedge funds and Pimco can unload them on you!
Dec 24, 2013 11:32AM
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There are far more Reason not to buy Bonds now then to buy bonds now. Near term movements won't mean much eventually because of.......

1)Japan Sale Tax going to first 8% than 10%
2)National Debt over $18Trillion and soaring
3)Global Debt Soaring
4)Fed Balance sheet Soaring
5)Unresolved Problem of $500-700Trillion in Scam Banking Derivatives
6)$4Trillion in Corporate Debt Due over the next 4 years
7)Record Margin Debt
8)Record Student Loan Debt
9)Massive China Credit Bubble
10)Europe Unemployment still over 12%

Dec 24, 2013 12:10PM
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where does 85 billion a month go anyway I don't see any of it does anyone know? you go into bonds and the yield goes up maybe and the principal goes down what a deal?
Dec 24, 2013 12:13PM
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It won't take a fortune teller to find out what's going to happen to the global economy. Fiat currency and hyper inflation are all in the cards. Batten down the hatches. Get ready for STAGFLATION at best. Either we pay the piper. Or continue to live in a wall street fantasy. Reality will set in sooner or latter. 
Dec 24, 2013 10:55AM
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Why not just wait for bonds to match the 4-5% return we should expect from stocks in 2014?
Dec 24, 2013 1:17PM
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Merry Xmas people and lets survive another year with good profits to boot.
Dec 24, 2013 12:58PM
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Today we take what we can get and we will like it....Merry Christmas and other Best Wishes.
Dec 26, 2013 12:11PM
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Bonds should always be a part of your investment portfolio.  I am not sure I would buy too many long term bonds right now, but as rates go up short and mid term bonds are a good investment.  Buy and hold until maturity.  Remember bonds are part of your entire investment portfolio.  A well balanced investment portfolio provides the best returns over time.
Dec 24, 2013 6:43PM
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I agree with Golden Professor Nick.....what planet is this writer from???  Geez...I am no genius when dealing with investments but even I know more than this guy does.  Personally, I would not place my money into anything that is directly backed by the government....what does that mean....figure out how to live within your means and stop all of this foolishness in trying to compete with the likes of Gates; Soros; Buffet and the rest of those high flyers....To an average investor, gains/losses of your funds in the marketplace are typically a big deal....to those guys, it is only a game.
Dec 25, 2013 10:38PM
Dec 26, 2013 12:07AM
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Invest carefully, understand your goals, how long before you need the money, when will you retire. We hopefully invested carefully, needed retirement income, needed money when we both were retired (2007).


We are presently in REIT's, Corporate bonds, index finds and annuities. Average percentage of income as a total is close to 5.75%. The only issue is the REIT's are gaining very, very little however we make about $900.00 a month with these. The principal has held it's own since 2008.

 

We look at our investments twice a year with our financial advisor and only tweak when it is prudent to do so. Will our strategy work for every one? Difficult to say however knowing the markets direction is tantamount to good investing. We learned years ago that investing is for the long haul and not quick hits on the new investment just coming on stream.

Dec 24, 2013 12:52PM
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Check out the replies to our posts, folks. Those IDs are financiers touching YOUR money and really LOUSY ones at that. Day after day after day after day of undermining. Why? Because it's been a SCAM since Day One. Close the banks, end the Fed (they vote soon on how to prevent future Fed's from bailing big crappy banks without the authorization and sign-off of the Treasury Secretary... won't that be nice for once?) and let's GET RID of Wall Street. We need AMERICA back and progressing, we need financiers digging ditches and cleaning port-a-potties again.  

Sheldon Adelson made more than $40 million A DAY in 2013. 90 million Americans were driven into destitution or suppressed to remain there. Let's RECOVER skill sets and competence. Let's dig a hole and BURY the 20th Century and it's racketeer society.  

Dec 24, 2013 10:38AM
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More Kool Aid. It's a FACT that bonds are incredibly toxic, tainted by ridiculous amounts of fake money, oversold and under-performing. If bonds are the home you live in and half the nation got to walk away or sell short of full settlement... what else could those bonds be but JUNK? Nothing that exists financially newer than 1999 has substance or stability. The only reason why this article appears today is because bond holders need new pigeons to replace them in the gone-bust line.

We lost everything in this Greed Run. We owe outrageously-- billions in artificial QE and $700 trillion syndicated debt (yes, that's right... look it up under- derivatives) and all we have to show for it are BIG platforms that won't pay family-sustaining wages, but retain colluding alumni to maintain a job blockade against those of us with skill sets and competence and force us to live indentured and in destitution.

Don't buy bonds, locate people like Sheldon Adelson who made more than $40 million A DAY in 2013 racketeering as a casino mogul, or the Walton Clan who have more assets (money) than 130 million other Americans, or the Koch Brothers who are insane terrorists funding our stagnation and lack of progress throughout the nation.

Time for CHANGE. You had better believe it.

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