Written by Nathan White, Chief Investment Officer of Paragon Wealth Management
We, along with many others, have been cautious about the bond market for some time. As the sun sets on QE the angst over when the Fed will start to raise rates and by how much is rising. Markets always like to price things in ahead of time and right now it seems the equity market’s recent nervousness could be due in some part to this interest rate uncertainty. The bond market however has not moved much yet. Many, including us, thought that the bonds would have a difficult year as they start to price in the rate increases. Instead, bonds have (so far) have had a good year surprising many. Alas, the inevitable is coming though and the window for bond gains is closing as we creep toward June of next year which is the most accepted time that the rate increases will begin. Any equity market weakness will give bonds more time to put off the reckoning.
Any rally in bonds should be sold as their time is getting short. I think you’re seeing the cracks appear in the high yield market right now. Historically, high yield is more correlated with the equity market and not that sensitive to interest rate risk but at these low rates it now contains interest rate risk as well. With yields still below six percent the reward is just not worth the risk for holding junk bonds.
Although we don’t find bonds attractive it doesn’t mean that a bloodbath is coming. It will probably be more like death by a thousand cuts. The Fed will be very slow and steady in raising rates as to minimize market disruption. After all, they do hold about $4.5 trillion of bonds! The first one to two percent moves from the bottom will be the most painful but in a gradual manner as mentioned. A year from now interest rate could be a half to one percent higher. Take a look at the duration of your bond holdings and compare it to your yield – you’ll be hard pressed to find anything that would come out positive…