3 Reasons Investors Should Stick with Bonds

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

"Bond crash dead ahead: tick, tick ... boom!" - MarketWatch

"Bonds worst investment of a generation" - Financial Post

"Waiting for the bond bubble to pop" - CNN

The headlines in the financial media are clear: bonds are on the verge of collapse! When interest rates return to their historical averages, popular funds like the iShares Barclays 7-10 Year Treasury ETF (NYSEMKT: IEF) and the iShares Barclays 20+ Year Treasury Bond ETF (NYSEMKT: TLT) could plunge. 

But some traders are bucking the consensus and calling the predicted fixed-income crash hogwash. Legendary investors like Bill Gross and Rick Rieder are starting to make bullish bets.

Here are three reasons these investors are sticking with bonds. 

It's a QE world

With interest rates at all-time lows, most investors logically assume rates must return to their historical averages. But that assumption might be a mistake. Central banks around the world are stepping up their bond buying programs in an attempt to juice economic growth. 

The Federal Reserve continues to buy $85 billion a month in Treasury bonds and mortgage-backed-securities with no plans to stop until the unemployment drops significantly or inflation spikes. Recent economic indicators suggest this is still a long way off. 

Globally we've see other central banks stepping up stimulus measures.

Last month, the Bank of Japan introduced the mother of all stimulus measures promising to inject $2.9 trillion into the market over the next two years in a attempt to wake the country's economy out of its two-decade funk. 

This week, the Bank of Australia surprised investors by cutting its benchmark interest rate to 2.75%. The measured was used to stem the strong Australian dollar that was hurting the nation's manufacturing industry. The ECB also cut its benchmark rate a quarter point to 0.50%.

Without a sudden rebound in economic growth, the path of least resistance for interest rates are down. 

No inflation in sight

Many investors are concerned that all of this money printing will lead to inflation. A slight uptick in prices could quickly wipe out a bond's real return.

Yet despite massive stimulus measures, inflation is rather tame at less than 2%.

How could the pundits be so wrong?

It's the private sector. Banks are choosing to park the new cash with the Fed rather than lending it back out into the economy. As a result, all of this new money just sits in reserves doing nothing. Don't expect any surge in inflation until this changes. 

It's all about supply and demand

Demographics favor lower bond prices. As baby-boomers head into their retirement years their need for income increases and their risk tolerance decreases. This will provide persistent demand for bonds in the future.

While demand is increasing, there's a shrinking supply of safe income products. The global pool of AAA government bonds has shrunk more than 60% since the financial crisis triggered downgrades of the United States, the U.K., and France. 

Foolish bottom line

So where are these bond bulls putting their money?

Legendary bond investor Bill Gross is bullish on 10- year U.S. Treasury notes. He thinks high interest rates in the United States will look attractive to yield starved Japanese investors. 

Rick Rieder, chief investment officer of fixed-income at Blackrock, is even more aggressive buying long-term 20-year U.S. Treasury bonds. 

Jeffrey Gundlach, founder of Doubleline Capital, also likes Treasuries but warns investors should avoid junk bonds like those offered by the iShares iBoxx $ High Yield Corporate Bond Fund (NYSEMKT: HYG). While the ETF yields a hearty 5.85%, defaults could easily exceed 4% resulting in returns lower than U.S. Treasuries over the long-term.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

Robert Baillieul has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus