FOR INCOME INVESTORS, IT'S ALL BULL
If you're familiar with bonds, you probably know who Bill Gross
is.
Known reverently as the "Bond King," Gross manages the
Pimco Total Return Fund, the world's largest bond fund. When Gross
speaks, bond investors and fund managers listen, including our staff
here at FMSbonds.
His recent comments in an Aug. 8th newsletter, however, took us
by surprise. He declared that a "new bull market" in bonds
had begun.
We never knew
It seems that according to market technicians, Treasury bonds have
been in a bear market (cheaper prices and higher yields) since the
Fed began its series of short-term interest rate hikes in June 2004.
Who knew?
Once again, the financial media, focusing on these comments, provided
a distorted picture to individual investors who buy bonds for income
rather than trading profits.
What bear market?
One of the reasons we missed the bear is our steadfast resolve to
encourage individual investors to buy longer-term bonds that promise
to pay a safe, steady stream of tax-free income. We recommend they
buy bonds when investment funds are available and not get caught
up in the futility of trying to predict the future direction of
interest rates (yields).
Those who have followed this strategy are very pleased they did
since there has been no bear market in municipal bonds.
Which rates are which?
On numerous occasions, we have lamented the fact that TV pundits
and the financial press have become enamored of pet phrases such
as "rising interest rate environment," while failing to
distinguish between the shortest of interest rates (Fed Funds) and
longer rates, which are most important to income investors.
Unfortunately, this type of misinformation has confused many individual
investors, keeping them on the "sidelines" in anticipation
of the promised higher rates, which have never materialized.
In fact, according to weekly muni bond indexes published by The
Bond Buyer, long-term yields have actually been declining while
short-term interest rates have been rising. When the Fed began its
series of tightening moves in June 2004, the long-term revenue bond
index yield was 5.40% and it never moved higher during the ensuing
period of rising short-term rates. Last week the index fell to 4.97%
and it is poised to move lower.
The income risk trap
We expressed concern in our commentary of Feb. 27, 2006, A
Forward Strategy For The Inverted Yield Curve, that bond buyers
would be enticed by the higher rates offered on shorter-term money
market instruments and abandon their successful strategy of buying
longer-term bonds. We said at the time that these investors, thinking
they were reducing their "market risk," were actually
exposing themselves to "income risk," which could prove
to be even more perilous.
Beware
Once it is clear that the Fed has sufficiently slowed the economy
and its tightening cycle ends, short-term rates will drop as quickly
as they rose, posing a reinvestment dilemma for income investors.
Unfortunately, at that point, long-term rates will likely be decidedly
lower.
Today, investors can still buy investment-grade tax-free bonds yielding
4.50% to 5.00%. These returns are comparable to 6.92% and 7.69%
on a taxable investment for an investor in the highest tax bracket,
and 6.25% and 6.94% respectively in the 28% tax bracket.
We think this makes a great deal of sense in this low-return economic
environment.
Bill Gross and his followers, who are fund managers and traders,
may discuss bulls or bears, but for the average investor concerned
with generating income, it's merely a distraction. Our focus is
on staying the course, keeping the interest clock ticking and maximizing
income on each purchase.
08/29/06
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