Time to Take Profits from Corporate Bonds?

Back in May of 2009, I wrote an article here in Money and Markets called “Time to Start Nibbling on Corporate Bonds.”

As the name implied, I argued that investors looking for opportunities in fixed-income were better off considering corporate bonds rather than Treasuries.

For example, I said:

“I am an unabashed fan of Vanguard’s low-cost funds, and when I look at the firm’s Intermediate-Term Investment Grade bond fund (VFICX), I am intrigued … I consider a 6 percent yield from extremely high quality bonds a pretty good deal.

“[So] if the choice is good income from a reasonably safe portfolio of corporate bonds vs. FAR less from Treasuries, I think I’d go corporate at this point in time.”

And I also took things one step further, noting that even junk bonds were presenting a good risk-reward tradeoff:

“Sticking with Vanguard, you’ll see that the firm’s High-Yield Corporate bond fund (VWEHX) is yielding about 11 percent. And you’ll get that with a very low expense ratio of 0.25 percent …

“I’m left wondering if all the current — and potential future — pain is already baked into the cake now. For someone looking for big yields, junk may very well turn out to be hidden treasure!”

Now, Over the Last Year and a Half
These Corporate Bonds Have Surged!

It’s no secret that investors have been flocking to bonds lately. But to get a sense of just how aggressively they’ve been buying, let’s take a look at what’s happened to the two funds I discussed a year and a half ago.

First, here’s a chart of the Vanguard Intermediate-Term Investment Grade (VFICX) since my original column …

As you can see, it’s up about 20 percent in nearly a straight line of gains!

And it’s the same story with the riskier junk bond fund, Vanguard High-Yield Corporate (VWEHX) …

This fund is up a couple more percentage points, in fact!

You’d see nearly the same kind of run-up in nearly any other type of bond or fixed-income fund you looked at, too.

I’d like to point out how highly unusual it is to see such sharp moves in these investments over such short time frames. Remember, we’re not looking at individual stock charts here.

Corporations are clearly milking hungry investors and low interest rates for all their worth right now … even as many of the lower-rated borrowers are seeing their fundamentals weaken rather than improve.

No Wonder Many Professionals Are Taking Profits
And Turning Their Attention to Other Investments!

Here’s how a recent Wall Street Journal article put it:

“Mr. Makhija is among a growing number of hedge funds and other professional investors that are getting out junk bonds and buying assets like mortgage debt and stocks instead. As they exit, mom-and-pop investors are flooding in, along with mutual funds that are usually dedicated to other investments …”

This is a shift that is worth paying attention to, especially if you happened to buy into corporate bonds back when I was first writing about them here.

Sure, the party could continue for some time — especially with the Federal Reserve’s new round of quantitative easing just getting started.

However, there have been some small cracks starting to develop in the bond markets lately … and it’s better to take profits a little too early than to watch things quickly reverse.

Where to go next?

I’m not particularly excited about any corner of the bond market at this stage. I’d rather stay on the sidelines and wait for better yields down the line.

In the meantime, I think dividend stocks remain the better income investments.

I’d note that based on recent numbers, many pros are now parlaying their recent winnings into higher-yielding stocks, too!

Bottom line: If you’ve enjoyed some recent gains from more aggressive bond holdings, you might consider taking at least a little money off the table. And if you’re looking to put new capital to work, equities look like the better choice … even after their relatively strong run.

Best wishes,

Nilus