Fixed-Income Market Commentary Archive

February 2009

January Fixed-Income Review

• Many times in the past we have seen a performance reversal where last year's sector leaders suddenly turn around and become this year's losers. Well one month doesn't make a whole year of course, but if anything it does perhaps signal the start of a trend. If that is the case, then Treasuries, last year's darling, could be in for an off year judging by the performance the sector turned in for the month of January. The twenty-year + component of the Treasury index gave back just over 13.0%, while the Treasury index overall lost almost 3.0%. The 30-year benchmark (aka the long bond) lost 14.5% for the month. On the other hand, the broader Aggregate Bond Index, whose 25% slug in Treasuries of varying durations is offset by exposures to other asset classes, was down a modest 0.8%. Therein lay the consequences (danger?) of a single-focused investment strategy. I point this out because many investors abandoned the diversified approach and flocked to the "safety" of the Treasury market during 2008. We have always touted the benefits of a balanced and diversified approach for investors seeking to remain invested, but with lower volatility. It is a strategy that remains hard to beat.
  
  
• Several thoughts jump out when reviewing the Treasury sector performance data referred to above. For starters, we are not exactly surprised by the reversal, though the depth of the abrupt turnaround was more pronounced than I thought we would see in just one month. We have said in previous comments that we thought Treasuries were expensive and that rates would likely rise. They certainly began to in January. The next thought is to point out that this riskless asset class is not without risk. There is no credit risk because they are guaranteed by the U.S. Treasury, but there certainly is market risk. Investors who may have recently purchased individual longer maturity Treasury securities that are now under water can take some level of comfort because at least they are being paid to wait -- just not as much as they may have if they bought today. The last thought is a reminder of the herd mentality we see from time to time. Now that Treasuries have started to sell off, some investors are ready to jump on board that bandwagon. In the past several weeks a handful of people have asked me how they can short the Treasury market. After advising they exercise a lot of caution, I tell them that there is an ETF that simplifies the task. For the record, I am not personally involved in or recommending the shorting of any securities -- fixed income or equities.
  
  
• Lower quality bonds, both investment grade and below investment grade, are continuing to be welcomed by the marketplace. The journal reports that a record setting $100B in investment grade rated bonds were issued in the first month of the year. This is a clear and welcome sign that investor risk appetites are returning and that corporations have the needed access to the capital markets. The relative higher yields on corporate bonds are far superior to the modest Treasury yields and that is no doubt helping the situation. I still believe that the biggest change is one I mentioned last month -- a change in investor attitudes away from the risk avoidance that filled the landscape not that long ago. The High Yield index continued its winning ways with a return of almost 6% in January. This is on top of the prior month's 7.6% return and suddenly we have a two month total return of 14.1%. I do believe there are additional and quite possibly exceptional returns to be had in the future from this asset class where the average dollar price on the bonds in the index is only .65¢ on the dollar. There very well may be setbacks along the way as nothing seems like a straight shot up. Headline and default risks remain high (there were several defaults in January) and investors are therefore urged to proceed cautiously and over a period of time.

Christopher Keith
Fixed-Income Manager