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Befuddled by Bonds

Let's simplify as much as possible what is occurring in the bond market, and what it means for investors.
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If you have trouble understanding the bond market's moves, or what those moves signal for the economy or markets, you are not alone.

At times, casual observers can be confused by the bond market, while those in the weeds can explain what is going on with a high degree of accuracy. Their explanations may be difficult to understand and quite wonky, but they are accurate.

Right now, however, there is a high degree of confusion and disagreement as to what is going on in the bond market.

We don't have the luxury of just dismissing bonds, so let's simplify it as much as possible to identify as best we can, what is occurring, and what it means for bonds (and stocks) going forward.

The Basic Explanation

The bond market is staggering, first from a series of hawkish comments, then from a series of dovish actions. Bond markets, a few weeks ago, were set up for central banks to continue to talk a bit hawkish, while acting dovish. Then the hawkish talk got aggressive and some central banks took action. That scared markets and pushed people out of trades (causing front end yields to rise (hike fears) and long end yields to fall (stifling growth too quickly). Then the Fed was dovish and more importantly, the Bank of England, who had guided to a rate hike, did nothing. That set in series another whole round of stop loss trading. Lots of other factors in and around this, but that is the basic explanation and one, from an enormous number of conversations, makes sense.

The 'Wonky' Explanation

At the more technical end, we have the Treasury issuing less debt, especially at the long end, for its next quarter. That is helpful for long bonds, as supply will be lower, offsetting the tapering. The appearance that the Fed and Treasury acted in concert, is also supportive. Then there is a belief that as stocks keep rallying, some selling of stocks to buy longer-dated bonds will occur in 60/40 funds. I can list more details, but as a whole, I think they are additive to the unwind theory, rather than being significant on a standalone basis.

TINA's Theory

I do not subscribe to this theory that says "There Is No Alternative", but am eyeing it. The view that with central banks back on the dovish side, you have to buy everything and anything with yield. With stocks at all-time highs and many sporting valuations that many find difficult to justify, maybe a 30 year bond at 1.8% doesn't sound so bad?

I don't like this theory, but have to give it some credence.

What's Next?

Investment-grade bond exchange-traded funds should do OK, such as the iShares iBoxx $ Inv Grade Corporate Bond ETF (LQD)  and the Vanguard Long-Term Corporate Bond Idx Fund ETF  (VCLT) .

High yield and leveraged loan funds should do well (iShares iBoxx $ High Yield Corporate Bond ETF (HYG) , SPDR Bloomberg High Yield Bond ETF (JNK) , Invesco Senior Loan ETF  (BKLN) , SPDR Blackstone Senior Loan ETF  (SRLN) ). These should track Emerging Markets a bit (iShares MSCI Emerging Markets ETF  (EEM) and iShares JPMorgan USD Emerging Markets Bond ETF  (EMB) ) as well as small caps (the Russell 2000 fund (IWM) ). To be honest, if the worst is behind us, emerging market bonds, offer better total return opportunities than high yield or leveraged loans.

On the back of this, I like Closed End Funds (though the discount to net-asset value is too small for me to add any right now), and business development corporations (VanEck BDC Income ETF (BIZD) ). While not a direct fallout of this analysis, I still like master limited partnerships MLPs (like  (MLP) ).

I am neutral on TIPS, or Treasury Inflation-Protected Securities, as I think inflation can surprise to the upside, but treasury yields could creep marginally higher.

On stocks, I like cyclicals, commodities, anything involved with U.S.-focused manufacturing and logistics.

I do not like some of the high fliers (like the ARKK fund  (ARKK) ) as we are seeing far too many 25% daily drops for comfort, and investors seem very long these stocks as they chase returns into year end, and I think that will be a mistake.

At the time of writing, Tchir has some long and some short positions in ETFs and stocks mentioned.