In uncertain times, investors are seeking the relative safety of more the stable bonds and their related exchange traded funds (ETFs). But choosing the right bonds within the helter-skelter will be the challenge.
Bonds usually receive lower returns compared to stocks because of less risk, but since Jan. 1, 2000, bonds have outperformed stocks by more than 50%, according to The Herald Tribune. One such ETF reflecting this trend is iShares Barclays 20+ Year Treasury Bond (TLT), currently up 36.7% year-to-date, with a yield of 3.93%. Investors may continue to find bonds attractive, since stocks may not return to normal for the time being. However, there are those who think bonds are trotting into “overvalued territory.”
Recent deflation woes have caused conventional government bonds to plummet, but inflation-linked bond yields have been rising, reports Paul Amery for Index Universe. Treasury Inflation-Protected Security (TIPs) real yield rose from .9% in March to its peak of 3.15% on Nov. 21, now currently around 2.6%. One such TIP-related ETF, iShares Lehman TIPS Bond (TIP), is currently up 0.2% year-to-date, with yield of 7.83%. The fall in price of inflation-linked bond indices have shown a rise in real yields.
A way to compare conventional (fixed-rate) and inflation-linked bonds is to calculate the break-even inflation rates for different inflation-linked securities. You take the average annual inflation rate over the life of the bond by the the difference between the inflation-linked bond’s real yield and yield on a fixed rate bond of a comparable maturity.
If the actual inflation rate is higher over the period than the break-even rate implies, the inflation-linked bond should be bought at the expense of the fixed-rate bond. Or vice versa, whichever the case may be. At present, investors may only invest in inflation-linked bonds in the U.K. and the U.S. markets.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.