For a while after the Q4 2008 simultaneous crash of nearly all forms of assets, bonds recovered and stocks did not.  However, of late, bonds are not so strong.

The charts shows the daily percentage price performance of key US bond types since the peak for aggregate bonds on September 15, 2008, and for 2009 YTD.

click images to enlarge

2008 from September

2009

From September 15th:

• BND (aggregate bonds): DOWN 0.7%
• IEF (7 to 10-yr Treasuries): UP 4.4%
• TIP (inflation protected Treasuries): DOWN 7.5%
• MBB (mortgage backed bonds): UP 3.0%
• MUB (muni bonds): UP 0.4%
• LQD (investment grade corporates): DOWN 2.9%
• HYG (junk bonds – not shown): DOWN 20.6%
• SPY (S&P 500 – not shown): DOWN 37.6%
• EFA (MSCI EAFE – not shown): DOWN 39.3%
• EEM (MSCI Emerging – not shown): DOWN 36.1%
• VNQ (MSCI REITs – not shown): DOWN 59.4%

From December 31st:

• BND (aggregate bonds): DOWN 2.7%
• IEF (7 to 10-yr Treasuries): DOWN 4.6%
• TIP (inflation protected Treasuries): DOWN 2.2%
• MBB (mortgage backed bonds): UP 0.2%
• MUB (muni bonds): UP 0.5%
• LQD (investment grade corporates): DOWN 6.9%
• HYG (junk bonds – not shown): DOWN 10.6%
• SPY (S&P 500 – not shown): DOWN 18.1%
• EFA (MSCI EAFE – not shown): DOWN 22.7%
• EEM (MSCI Emerging – not shown): DOWN 15.0%
• VNQ (MSCI REITs – not shown): DOWN 34.5%

Except for junk bonds, there are no large category disasters in the group as there are in equities, although the investment grade bonds have been a disappointment.

BND:
Aggregate bonds are a composite of all bond forms, except municipal bonds and those under one year maturity. If most bond types are down, the aggregate will have a hard time rising. The aggregate includes agency bonds which have been doing OK.

IEF:
Treasuries are down YTD, because buyers are demanding higher yields to absorb the unprecedented issuance volume. If fear rises sufficiently, Treasuries will rise again, but longer term they must fall as rates must eventually rise.  That makes Treasuries more of a sentiment trading vehicle than an investment vehicle for the time being.

TIP:
TIPS are down as inflation seems farther and farther away, as some economists begin to talk about global stagdeflation (the opposite of the stagflation of a couple decades back).

MBB:
Mortgage backed bonds (agency issued) have received government assurances of federal backing and are therefore high in the capital structure.  Note, however, that they have prepayment risk if mortgage rates continue to fall, or if government programs rewrite mortgage rates. That means you can’t lock in rates with mortgages they way you can with Treasuries and some other bonds.  The government backing is most probably for the principal amount, but not the rate — we don’t know that, but suspect that to be the case.  We have no idea what would happen to principal values if the government backing of the bonds came into conflict with a possible government action to reduce principal amounts on defaulting mortgages. As with TARP related bank securities, the outcome is highly government policy dependent, and government policy is not consistent or settled.

MUB:
Municipal bonds are holding up, but are not stellar, perhaps because fears of default are less with the impact of the stimulus package and expectations that if the US will save AIG and GM, they would likely save California.  Municipals bonds may also be buoyed by the certainty of higher income taxes at the federal level, and perhaps at the state level in some states.

LQD:
The AIG disaster, the GE disappointment, and the creeping nationalization of banks (with last week’s crushing of Citi preferred shareholders by government policy decision), all lead to great fear that bank bonds may be next to take a haircut. Bank bonds are an important part of the investment grade corporate bond market.

Investing in bonds along with TARP in banks, suggested by some leading bond managers, does not seem to be such a great idea.  Government policy is too uncertain, maybe even fickle, to take comfort with either debt or preferred equities in banks. First came bank common dividend cuts (two cuts in a row at BAC).  Now we have preferred dividend termination (Citi: C).  Next may be bank bond interest or principal haircuts.

HYG:
Junk bonds are down, because they are junk, which has poor prospects in a poor economy.

Richard Shaw
QVM Group LLC

Last 5 posts by Richard Shaw

• Hold Reserves, Loan Money or Own Something - November 23rd, 2009
• Are negative yield money funds next? - November 19th, 2009
• Old Normal Allocation Becomes New Normal? - November 17th, 2009
• Very Long-Term Asset Allocation Results - November 8th, 2009
• U.S. Healthcare Legislation Investment Impact - November 8th, 2009