About six weeks ago in one my blog posts on income investing I wrote:
http://twocents.blogs.com/weblog/2008/06/recognition-wave.html
"Unless we have a deflationary collapse starting soon, bonds have nowhere to go but down. There is still a small group who believe that the deflation of 1996-98/99 will recommence after this inflationary interlude of 8-10 years. I myself have felt that a timeout or rest period in inflation was due, especially if a deeper recession occurred. In that case one would expect a decent bond rally. However, barring amazing collapses of multiple financial institutions and a permanent contraction of credit in its wake this year, there will be no long term bond rally until rates are much, much higher in a decade or more."
Much sooner than I would have thought possible we have had "amazing collapses of multiple financial institutions" and evidence of credit contraction not just in the markets but also at the bank loan officer's desk, according to the FED's loan officer survey. And the new (and long due) rules for rational credit rating of mortgage applicants, proposed this week, will constrict it more. Bonds are still bouncing around, but we are seeing a fracture in the bond market. Treasuries and GNMA's ("full faith and credit....") and municipals are holding up and rising slowly, but corporate bonds, especially high yield or junk bonds, are not.(Incidentally, there is now a good way for those of us without a Bloomberg terminal to get a feel for what junk bonds and munis are doing. HYG is the symbol for a junk bond index ETF and MUB is the symbol for a muni bond index ETF.) This parting of ways or "widening of the spread" between junk and treasuries has been taking place while crude oil and gold have been re-exploding upwards and a commodity mania has become acceptable on Main Street. It bespeaks an approaching recession.
As a former commodity futures trader before I got old and gray, my gut feeling, based on the history I know, has been that we would have a significant pull back or at least leveling out in commodity prices, including gold. We've had several periods like that since the lows of 1999-2003, and it is common in commodity bull markets. Whether it really started today or not is foolish to speculate about, but I have been cutting back on commodity exposure in recent weeks just as I cut back on "generic" stocks last year and early this year. As mentioned I sold one-half of my high yield oils and gas trusts. I did buy TYG the infrastructure closed end fund, but did not buy KYN and MGU. Not did I add on to ETO or buy DRP. I still like them at some point, but I'm going to wait. I cut back to minimal positions in VGENX and VGPMX the Vanguard managed petro and the managed mining funds. PCRIX has also been pruned and the rest hedged by the long/short commodity/currency fund from Rydex--RYMFX. Gold is untouched. This is the lowest exposure to inflation/commodity vehicles that I have had since 1998. I may be wrong but if so I can buy them back. But I do think the long bull market for commodities, which I see lasting into the 2020's, is going to take another breather.
Recently I saw another of Kate Welling's dynamic interviews, this one with Albert Edwards and James Montier of Societe Generale. Read it. It's a bit of a circuitous route to get to it: go here first:
Then click through to the Investment Postcards site, and finally to Welling@Weeden. Edwards and Montier are bearish not only on the world stock markets, including emerging markets, but also on commodities. This interview is over a month old, and some of what they foresaw has occurred. I'm already basically out of stocks except for the minuscule position in ETO and residuals in the trusts, so it's easier for me to relate to this forecast. In fact I'm mainly interested in Edwards and Montier because of the implications for bonds which is "where I live" these days.They don't talk much about bonds or the dollar except to mention that both could go up, but I think that is the big news for dollar-based income investors.
I had cut back duration or maturities both in municipals and in taxable bonds, thinking that increasing rates would take a big bite out of total assets. Also I can make nearly as much interest on 4 year GNMA's (VFIIX/VFIJX), which are as safe as Treasuries, as I could on 20-30 year Treasuries. So I figured why go out long term? In fact I also bought Vanguard's short term federal fund VSGDX which is essentially two year GNMA's.
Hildy and Stan Richelson wrote a fine book "Bonds: the Unbeaten Path to Secure Investment Growth", 2007. I bought it this weekend at Amazon and it is also available form Bloomberg Books who had a hand in publishing it. This is the Gospel of 100% bond investing. I think it was $16 at Amazon with almost as much for one day delivery. Even you are a bond dealer or trader there is much to learn here. To make this short, I learned that my approach hasn't been all that bad, since their main goal is to produce income to live on while being safe from the ravages of stock volatility in a retirement portfolio. I had been feeling my way there, but I think I'm nearly home. I plan to keep my bond duration/maturities fairly short since I do not know for sure (who does?) which way rates are going. I had been toying with the idea of small positions in either long-dated TIPS or long-dated strips (zero coupon) treasuries. When I read the Michelson's "bar-bell" duration strategy I knew I was onto a good idea. The concept is to have short duration for safety but some long duration exposure to extend the average duration out to the intermediate term, say 5-7 years. The Michelsons like long duration individual bonds, but I do not work with an adviser and want to keep accounting simple and under one roof, namely at Vanguard where I can buy almost anything through their clearing house arrangement for client brokerage with Pershing. Almost all my taxable bonds and high yield investments are in tax-deferred accounts, and the municipals (also fairly short duration--2-3 years) in taxable accounts. Taxes are surely going up next year no matter who gets elected, and the best we can hope for is that it is only Bush tax cuts which are allowed to expire and not new increases on top of that.
Since TIPS are long term inflation-adjusted US Treasuries and Strips are long term zero coupons, and hence leveraged, which should do better in a disinflationary environment, it seems to me that switching between TIPS and Strips is the way to go at the long end of the "bar-bell". There several mutual funds for doing this but there are also several ETFs now. TIP and EDV. TIP trades in decent volume, EDV the Strips ETF from Vanguard is pretty new and trades very little. Vanguard has not wanted to publicize it at all for fear that small investors might load up on it and lose a lot if rates went up. But as a "duration kicker" if rates are going down, you effectively get double the leverage of a regular Treasury bond fund like TLT. the advantage is that I can leave most of my bonds at the short end and use TIP and EDV alternately in bond price excursions due to inflation or disinflation. If this isn't clear to you, just forget about it or read the Michelson's book. They don't talk about this strategy specifically but do explain all about these two bond types. It's not necessary to do this at all, but it will give me something to do to add value with TIP or EDV. Be sure you use strict and realistic limit orders if you deal with these two, especially EDV. I bought a tiny, tiny first position of EDV today, just to focus my attention. By the way, both TIP and EDV pay monthly dividends. I've been thinking about and writing some about inflation-hedging an income portfolio, but one can also disinflation-hedge it with EDV.
If you are into this at all, do get the Michelson's book for $20-$35 including shipping, and read the Kate Welling interview. Bear in mind always that I am just talking about what I am doing, and I am not making investment recommendations for anyone except myself and family. Based on what I've been doing this year my total investment accounts--not including checking account, home, personal items, etc.--are up 4.72% year to date. Not fabulous by any means, but I'm thankful when I hear horror stories of some friends who are also retired and have taken big hits in stocks. If you are a chicken like I am, read the Michelson's book.
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