Buy-and-Hold Might Be Dead For Stocks—But Not Bonds
Buy and hold may be dying as a stocks strategy, but it's gaining new favor for those in the bond market.
With the United States facing an uncertain economic future and yields hovering around attractive valuation levels, some managers are beginning to advise clients to hold longer bonds and collect income rather than seeking principal return in the shorter term.
Most recently, Barclays Wealth told clients this week to change from a short-dated approach to bonds and start holding longer maturities.
The recommendation is based in part on yields that are approaching 4 percent for the benchmark 10-year note and 4.75 for the 30-year bond.
Barclays considers slow post-recession growth typical of the post-War War II economy as the most likely scenario. But it makes ready for the possibility that when government stimulus ends and as the Federal Reserve has no room to cut its funds rate, consumers will not be healthy enough to continue to generate growth and the economy could enter a double-dip period.
"It's a little atypical to say duration is portfolio protection," Elizabeth Fell, investment strategist for fixed income at Barlcays, said in an interview Thursday. "But given our secondary scenario where we have a double-dip, it's the right type of protection we are promoting."
At its core, the strategy usually involves a portfolio technique called "laddering," in which bonds of varying maturities are combined in a portfolio to take advantage of changes in interest rates.
"A laddered portfolio is a common strategy in which you will have sequential maturities," Fell said. "Investors can take advantage of a changing rate environment either by locking in rates or reinvesting at higher rates."
To be sure, buying long-dated securities—much less the notion of holding them to maturity—has its share of dangers and detractors.
The bond market can be something of a trader's playground, with owners looking more to capitalize on gains in prices while fearful of higher yields that suggest greater risk. But with last year's stellar performance among high-yield bonds and tumbling default rates, the dynamics of the fixed-income world have changed.
"I keep seeing people owning things they don't understand," said Dennis P. Barba Jr. professor at Case Western University's Weatherhead School of Management. "When interest rates do go up, these longer-term fixed income securities are going to go down in value."
The most vocal opposition comes from those who think the US is entering an environment of higher interest rates caused by inflation and the government's continued need to finance its debt.
Under such conditions, bonds will fall in price as inflation erodes the value of fixed-income investments.
"The risk when you go long is you are making a bet that interest rates aren't going up for 10 years," said Peter J. Tanous, president and director of Lynx Investment Advisory in Washington, D.C. "I think that is one hell of a bad bet giving everything we know about supply."
In that line of thinking, Tanous and others advise the opposite strategy—buying extremely short-dated Treasury bills and rolling them over to capture gains in price movement, or alternatively to get better yields if rates keep going up.
But those favoring going long believe that 10-year notes, for instance, provide value particularly if investors take the strategy of financing for the intermediate term and holding for the long term.
Investors can finance a 10-year for, say, three years at the current rate of 1.65 percent or so—and then capture clear gains afterward on what essentially becomes a 7-year note, said Don Galante, senior vice president of fixed income at MF Global in New York.
"The market is fairly priced. That doesn't mean we can't go back and forth, but I don't think we're going to an all-out collapse of the Treasury market," Galante said. "We're going through an orderly move higher with the markets."
Indeed, few are predicting that rates won't rise at least a bit through 2010.
Barclays is projecting the 10-year to hit 4.50 by a year's end, in line with a number of other firms that allows for some movement but not enough to threaten the value of fixed income.
"In one sense you don't want to go out too far on the curve with trillion-dollar deficits as far as the eye can see," said Kim Rupert, managing director of fixed income strategy for Action Economics in San Francisco. "For immediate considerations people are tired of zero percent or half-percent yields, so they want some more. Treasurys give them that, plus safety."
Buyers Still Out for 'Safety Protection'
This week's Treasury auctions gave further proof of how fickle the market can be.
Just as the 10-year touched 4 percent Monday and looked ready to jump higher, investors provided signficantly higher demand for successive auctions this week, sending yields lower and for the moment squelching worries about demand for unprecedented levels of supply.
In fact, it could well be market murmurs of higher rates ahead that send contrarian investors into fixed income believing that deflation could be a more likely scenario for the economy. Federal Reserve Chairman Ben Bernanke contributed to the case for deflation when he said in a speech Wednesday that the economy is "not out of the woods yet."
"The bottom line is that credit is still contracting and this is purely a deflationary phenomenon," Gluskin Sheff chief economist David Rosenberg wrote in his morning note Thursday, citing recent data showing a drop in consumer credit of $11.5 billion in February.
"The primary trend, and this is definitely not the mainstream, is one of deflation, not inflation," Rosenberg said. "The fact that so many believe in inflation makes this theme that much more appealing."
The other issue is of holding for an extended period of time and even maturity, or "buy and hold until further notice," as Aaron Gurwitz, Barclays' head of global investment strategy, put it at this week's outlook presentation.
Rupert said the strategy is popular among institutional investors and certain Japanese and US funds that need yield. But Barclays' Fell said retail investors can use the strategy as well as a portion of their portfolios dedicated to protection against another downturn in the economy.
"What we're asking from our fixed-income allocation is to act as a safety protection part of the portfolio," Fell said. "We have a very high-quality asset that is going to appreciate. We are not predicting (a double-dip) but it is our secondary scenario and given the fact that we have nowhere to go from a Fed funds perspective, we have fewer tools in our tool kit."
Counting on a fixed-income asset to hold its value for so long is a risky proposition, said Walter Zimmerman, chief technical analyst at United-ICAP in New York.
"The technical picture as we see it presents an absolutely compelling open-and-shut case for a long-term uptrend in interest rates," said Zimmerman, who sees the 10-year hitting 6 perent and the 30-year eclipsing 7 percent. "Assuming that I won't need money for the next 30 years is a wildly optimistic assumption. If you do need it you're going to get hit really hard if our interest rate forecast is even half-correct."