Bond dilemma: Is market signaling a buy or a sell?

Financial advisers are back on the horns of a dilemma after a rare period when both stock and bond prices advanced.

Since June 16, bond prices have nose-dived. But whether this represents a buying opportunity or a selling signal is far from clear, and many advisers – after an all-too-brief respite – feel that gnawing sensation in the pit of their stomachs.

Kevin J. Bannon, chief investment officer of BNY Asset Management, says adviser angst reflects a market slack tide.

“The bull market for bonds is over, but I don’t think the bear market has started,” says Mr. Bannon, who oversees $83 billion for the investment management division of The Bank of New York Co. Inc.

“To be honest, we’re struggling with this,” says Jason M. Weybrecht, vice president of Spero-Smith Investment Advisers Inc. in Cleveland, which has $200 million under management “We are trying to go back and take advantage of these rates. But we’re still just not confident.”

taking what’s there

Nobody wants to catch a falling knife, but buying low and selling high is the name of the game.

With so much uncertainty, Derek Jaskulski, strategic analyst with Portland (Maine) Global Advisors LLC, says his firm is willing to take some of what the market is giving, and is cautiously buying bonds. Mr. Jaskulski’s firm manages $60 million.

Many assets typically allocated to bonds were parked in cash at Portland Global as the advisers waited for yields to improve.

“We have a lot of clients we’ve been waiting to buy bonds for,” Mr. Jaskulski says. “Historically, it’s not a great level, but 4.5% is better than 3.5%.”

But Ron DeLyons, CEO of Greystone Investment Management LLC in Cincinnati, which manages $280 million, says it’s a rough time to reallocate into fixed-income securities.

“The horse is out of the barn, so it’s hard to shift today,” he says. “We’ll wait till yields are at 6% or 6.5%, then look at [how that yield compares with] dividends in the S&P 500.”

Mr. DeLyons says his portfolios are as much as 90% invested in equities, though the equities include large investments in yield-heavy real estate investment trusts. He uses REITs as bond substitutes.

Many advisers report that despite the dangers of investing in bonds – particularly long-duration ones – clients want more emphasis on this perceived safe haven.

Indeed, The Bank of America recently completed a survey to show that this is an opportunity for financial advisers.

The report indicates that 51% of Americans with more than $100,000 in investible assets were doing nothing to prepare for a rising income environment.

In fact, the survey notes that 37% of these investors had 25% of their assets in long-term bonds, and 16% had 50% in long-term bonds. Eighty-four percent of the respondents said they had no plans to change that allocation.

Mr. Bannon says The Bank of New York is convinced that advisers should pay more attention to allocations than to playing interest rate swings.

“People need to keep some allocation in bonds,” he says. Just because bond prices have declined doesn’t mean that advisers investing in bonds are wrong, he says.

Mr. Bannon says his firm’s tendency has been to keep allocations the same but to buy longer-maturity bonds.

Meanwhile, Don Peters, a principal with Central Plains Advisors Inc. in Witchita, Kan., says his firm is once again 100% invested in bonds after withdrawing 50% from the market for a few weeks in July when yields fell particularly low.

But Mr. Peters, who manages $35 million of assets primarily for clients of independent investment advisers, says they’re as nervous as cats.

“I’m holding their hands because everything they see everywhere else tells them otherwise” about the wisdom of holding bonds, he says.

a look at history

Mr. Peters says that his confidence stems from his historical studies of inflation.

Traditionally, 30-year government bonds yield 2.5% after inflation.

With inflation running at 1.5%, he says 30-year bonds are paying a historically high interest rate, and people should lock in that income.

Mr. Peters says people are looking for a greater premium than 2.5% because of their fear of inflation.

But the economy could grow as much as 4% and still keep inflation close to 1% based on history, he notes.

Mr. Bannon agrees that the past 30 years of inflation have been a misleading indicator of how economies work.

“Baby boomers grew up thinking inflation was the natural order of things,” he says. “Investors have been so concerned about protecting their principal that they’ve forgotten to protect their income.”

With bonds in such a volatile state, Mr. Weybrecht says his firm is now considering a strategy it would have passed on previously – buying bond mutual funds. He says the funds can find the bonds they want at the prices they want. He also likes the fact that they don’t face reinvestment risk.

There is humility in this approach. “Can we beat what [Pimco chief investment officer] Bill Gross can do?” Mr. Weybrecht asks.