3 Bond Winners Leading the Pack in This Bull Market
So far, 2014 has been a very good year for bonds of all sorts — corporate bonds, Treasury Bonds, emerging market bonds, and so on. It is hard to explain this from a fundamental standpoint. Interest rates are extremely low already, and rising bond prices means that they are falling further. This means that investors aren’t being incentivized to lend their money out. However, there are institutions subsidizing this — most notably the Federal Reserve and other central banks. These institutions are buying bonds and making it less expensive for banks to borrow money. Banks, in turn, then have additional money to make riskier loans. So, for instance, even if it doesn’t make sense to lend money to a certain institution at 3 percent interest, the fact that there are banks that can borrow money at 2 percent to lend it out at 3 percent gives them incentive to do so.
This process is ultimately creating a bubble in bonds — eventually bond prices will fall and interest rates will rise to reflect the risks entailed in lending money. But until then, bond prices are rising, and from a trading perspective, there are several opportunities out there. The three bond funds I list here have all had excellent year-to-date 2014 performances, and they have all outperformed the S&P 500. They also pay a coupon that exceeds the dividend yield you can earn on the S&P 500. Furthermore, they are all in clear uptrends and they all make for solid trades, at least in the near-term. Keep in mind, however, that they are trades, and that as a trader you should take the necessary precautions to prevent losses in the event that the market turns south. This means using stop orders, or options if you are more sophisticated.
1. The iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT)
Simply put, this has been one of the best performing ETFs of the year, with shares up 12 percent excluding interest. This fund holds long-term Treasury Bonds, and as you know, interest rates on U.S. debt have been falling. At the beginning of the year this was one of the most hated asset on the planet, and so from a contrarian perspective its outperformance is not surprising. There has been a lot of support from the Federal Reserve despite the fact that it is tapering its buying. There has also likely been a lot of short covering. Now there are a lot more bulls on long-term Treasuries and so I’m not sure how much longer this fund can rise. You might prefer to take a chance with one of the riskier funds I mention in a moment. However, so long as the TLT is making higher lows and higher highs, it is worth being long with a stop order in place to protect your gains.
2. The iShares iBoxx Investment Grade Corporate Bond Fund (NYSEARCA:LQD)
The strength in this fund has been unusual given that it holds predominantly shorter term bonds. These bonds tend not to be as volatile as long-term bonds. However, despite this LQD, shares have risen about 5 percent for the year and the trend appears to be straight up. If you look under the hood, you’ll find that many of the holdings are “too big to fail” banks, meaning that they are implicitly backed by the U.S. Treasury. So many of these bonds are as good as Treasuries but with the potential for a greater return. I suspect investors will continue to bid this fund higher as they search for low-risk yield. Also, so long as banks can borrow money cheaply they will keep a bid under this fund. Like with the TLT, you can buy LQD shares and place a stop order underneath, and there is a good chance you’ll make money.
3. The Market Vectors High Yield Emerging Market Bond Fund (NYSEARCA:HYEM)
Like with Treasuries, investors hated emerging markets at the beginning of the year. Now they think emerging markets are just fine. This bond fund, which pays nearly 6 percent annually, has been base building and just broke out in the past couple of months. It was up over 2 percent in the past week alone and so far it is up more than 5 percent year-to-date. It is up over 7 percent if you count interest payments. This fund is riskier than the two that I first mentioned because it invests in the bonds of many higher risk emerging market companies. However, while their stocks are volatile, I doubt that many of them will go bankrupt. This means that they should be able to continue to make interest payments. Furthermore, these funds should benefit as investors bid up emerging market currencies, which have had a lousy couple of years despite the fact that their central banks don’t have anything like the Fed’s quantitative easing program in place.
As investors search for more yield, and as funds such as HYEM continue to rise in value, investors will be more comfortable in these higher risk funds. Therefore, so long as this bond bull market continues, HYEM shares should be a winner.
Disclosure: Ben Kramer-Miller has no position in the funds mentioned in this article.