Fund Spy
A bond manager sees more pain ahead for bonds
The 10-year bond is now yielding about 4.6%. Is it headed for a 6% yield?
By Russel Kinnel
Last week, I wrote that most bond fund managers believe the worst is over. But, of course, not everyone thinks that's the case. In June, FPA New Income (FPNIX) manager Bob Rodriguez shifted from cautious to downright bearish.
He declared a buyers' strike against Treasurys because their yields had dropped to record lows despite the fact that tremendous liquidity had just been injected into the economy via tax cuts and Fed rate cuts.
At the time, Rodriguez noted that the stock market's rally signaled a healthy growth spurt in the economy while the bond market was signaling sluggish growth or a recession coupled with deflation. He said the stock market was more likely to be right in this case. Low interest rates and easy money are combining to set the stage for rapid economic growth. Over the next twelve months, it would not surprise us to see real GDP grow faster than 4%, he said.
Actually made money
His bearish stance soon paid off as the bond market was pummeled in July, and his fund was one of a handful to actually make money for shareholders.
Despite the spike in rates, Rodriguez isn't tempted to go back in. Although the 10-year Treasury currently yields 4.6% (as of Thursday), he won't begin buying until it hits 5% -- and even then, he'll only gradually ease in. (To find todays 10-year note yield, check Leading Indexes on MSN Money.)
"This is only the start of a longer period of difficult bond market returns," he told me. "The base level of U.S. inflation is still in the 2% to 2.5% range," he said. "Given a minimum real return of 3% (that is, at least a 3% return above the rate of inflation), this would place fair value on the 10-year T-bond in the 5%-5.5% range.... It would not surprise us to see the 10-year T-bond yield rise into the 5.25%-to-5.5% range within the next 12-18 months."
A three-year quagmire?
As if that wasn't depressing enough, Rodriguez says there's a decent chance that bonds will be a quagmire for three more years.
"Assuming President Bush is re-elected, we expect that the odds of a difficult bond market in 2005 and 2006 are also rising. The combination of growing government entitlement debates along with a likely weaker dollar makes for a difficult bond market environment. Longer term, it would not surprise us to see the bond with a 6% handle (i.e., a yield between 6% and 7%). . . . The important thing to remember is that the bond bull market of the last 20 years is over. It will be more difficult managing bonds from the long-only side going forward."
Mind you, most bond managers are a little more optimistic than that. Rodriguez really hates to lose money, so he'll gladly err on the side of caution when it comes to protecting principal. (For another view, see Tim Middletons column, Battered by bonds? Don't run scared.)
(c) Copyright 2003. Morningstar, Inc. All rights reserved.
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