2. Mortgage Bonds On The Move – One of the areas of the market that was first to begin warning us of potential danger on the horizon back in May were mortgage backed securities. The iShares MBS ETF (MBB) is one of the larger proxies for this market with over $5 billion in total assets. The bonds held within this portfolio (along with treasuries) are some of the very securities that the Fed has been buying to keep interest rates artificially low.
Since the September decision by the Fed not to taper these asset purchases, MBB has been off to the races and is now trading very close to its long-term 200-day moving average. If this fund can climb above that technical level, it may set the stage for a larger comeback in mortgage securities that would lure additional money back into this space. I typically prefer to play this sector through the expertise of an active manager such as the Doubleline Total Return Fund (DBLTX). I have found the expertise in research, security selection, and risk management to be well worth the slightly higher management fee.
3. Municipals and Emerging Markets Snapback– Two of the most beaten down sectors of the bond market this year have been municipals and emerging markets which offer their own unique benefits and perils. Municipal bonds garnered negative headlines this year on the back of a bankruptcy filing by the city of Detroit. That combined with the headwind of rising interest rates set this sector back significantly. Emerging market bonds were largely dumped due to the severe underperformance of both equities and currencies in underdeveloped overseas markets.
However, often times the biggest decliners are the ones who snap back the hardest. Consider that the iShares National Municipal Bond ETF (MUB) and iShares Emerging Market Bond ETF (EMB) jumped 2.79% and 3.15% respectively in the month of September. Performance like that is typically reserved for equity-like positions. Both of these ETFs carry an effective duration of over 7 years, which contributed to the push higher when interest rates fell last month.
Right now I am continuing to avoid exposure to these sectors in favor of sticking with fixed-income holdings that offer better relative performance and shorter durations. I would be using this short-term strength to sell any lingering exposure and look to rotate into more defensive holdings.