We
all watched as the government shut down and witnessed how dysfunctional
Washington has become. During this time the stock market held up rather well
while interest rates on bonds tended to go up. As bond interest rises the value
of the bonds decline. The impact on the bond market was reversed once a deal
was struck. Bond interest rates have come down to a point we have not seen
since mid-May, in some cases. For now, the Federal Reserve(Fed) continues to
purchase about $85 Billion of mortgages and bonds each month to assure
liquidity and continuing expansion of the economy. At some point in the future,
the Fed will reduce and then eliminate their purchases. When this happens it is
expected that bond interest rates will go up and the value of bonds will go
down. It is likely that this reduction in purchases will not take place until
mid-January when the new Chairperson of the Federal Reserve takes over. For
now, there is a lull in the bond market. To counter the potential increase in
interest rates, it seems wise to move bond investments into shorter duration
bonds that pay little but have a lower risk of principal devaluation. For those
portfolios that are largely in bonds, like a Conservative portfolio with 80% in
bonds, there will likely be a reduction in earnings and negligible gains in
principal by using this strategy. My guess is that this will all be played out
during the next 12 to 18 months, after which time investment grade bonds should
stabilize and become the sound investment that they are intended to represent.
For now, I see an opportunity to rebalance portfolios to reduce the chance of
principal loss in bonds.
Ed
