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May 14, 2003 at 08:00 PM
May 12, 2003 — Given the choice of throwing a bomb or dumping the ball off to a running back, bond market observers say the short game is best for the time being.
Fixed-income securities that mature in less than five years are attractive because they stand to be hurt the least if interest rates begin edging up later this year or in early 2004, investment professionals say.
Despite their recent rally and their inherent danger of defaulting, high-yield, or so-called junk bonds, are another alternative to consider, some say.
“Generally, right now, you don’t want to be too long, to my mind,” says David Wyss, chief economist at Standard & Poor’s. “If you look at the yields, I don’t see much point in going out past five years,” he adds.
Among Treasury and corporate bonds, Wyss says he favors those that come due within 2-3 years. He’s not enthusiastic about intermediate-term debt securities because if the Fed begins ratcheting up rates, they would carry “a fair amount of principal risk,” that is, the possibility of losing face value.
Similarly, long-term bonds and bond funds “will certainly take a hit” when rates move up, says Joel Friedman, an S&P director. For example, he points out, a 1% increase would cause a portfolio with an intermediate-term duration (a measure of sensitivity to interest rate changes) of five years to decline 5%; the loss for holdings with a ten-year duration would be 10%.
As for rates, William Reynolds, who heads the fixed-income division for T.Rowe Price Group (TROW), sees them heading higher, although the move “doesn’t appear to be imminent, given the state of the economy, which is sluggish, at best.”
Still, bond investors need to begin positioning themselves for the hike, starting this summer, and favoring short-term maturities is “a reasonable step,” says Reynolds, whose unit oversees about $50 billion in assets.
Wyss says the Federal Reserve could lower rates next month if data on the economy continues to be discouraging, but after that the central bank will begin tightening, he believes. However, the move up probably won’t start until next year because there doesn’t appear to be a threat of inflation on the horizon, and the economy’s performance has been lackluster, he says.
