Monday, October 21, 2013

The After Glow

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.