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CMG Capital's Blumenthal: How to Protect Yourself From a Bond Bubble

By    |   Tuesday, 27 May 2014 12:41 PM

Bond investors must strive to protect themselves from a likely bond bubble, urges CMG Capital Management CEO Steve Blumenthal.

"Most investors are unaware and ill-prepared for the impact that rising interest rates will have on their bond funds and ETF [exchange-traded fund] investments," Blumenthal writes in an article for Forbes.

Thirteen of the 16 Federal Open Market Committee [FOMC] members believe the Federal Reserve will begin raising short-term rates in 2015. One thinks the Fed will start raising rates in 2014, and two see rate increases starting in 2016.

Editor's Note: 250% Gains Bagged Using Secret Calendar (See Video)

In addition, their median year-end Fed funds rate target is 1 percent, up from 0.75 percent from three months ago, while the year-end target for 2016 is 2.25 percent, up from 1.75 percent.

"All of this suggests that the FOMC will begin hiking rates sooner and perhaps more aggressively than what investors may be expecting," Blumenthal writes. "Rising rates spell trouble for unsuspecting bond investors."

A 1 percentage point rise in the 10-year Treasury yield, from 2.5 to 3.5 percent, would cause an estimated 8 percent loss in principal, and yields rising to 6.5 percent would prompt a 29 percent principal loss.

To protect them, Blumenthal urges bond investors to "tactically trade" bond funds and bond ETFs using the following process:
  1. Score a +1 when the Dow Jones 20 Bond Price Index rises from a bottom price low by 0.6 percent. Score a -1 when the index falls from a peak price by 0.6 percent.
  2. Score a +1 when the index rises from a bottom price by 1.8 percent. Score a -1 when it falls from a peak price by 1.8 percent.
  3. Score a +1 when the index goes above its 50-day moving average by 1 percent. Score a -1 when the index crosses below its 50-day by 1 percent.
  4. Score a +1 when the Fed funds target rate drops by at least half a point. Score a -1 when the rate rises by at least half a point.
  5. Score a +1 when the yield difference of the Moody's AAA Corporate Bond Yield minus the yield on 90-day Commercial Paper Yield goes above 0.6. Score a -1 when the yield difference falls below -0.2. Score it 0 for a neutral score between -0.2 and 0.6.
Add the total of steps one through five once a week. If the sum is +1 or higher, Blumenthal suggests investing in a total bond market ETF. If the aggregate score is -1 or lower, he says to reduce your portfolio risk by shortening the maturity and buying short-term Treasury bills.

"With interest rates near historical lows, it is inflation and rising rates that present considerable portfolio risk," Blumenthal writes. "It is time to tactically trade fixed income exposure. The bubble of all bubbles may just be in bonds."

Others believe fears of a bond bubble are overblown. The bond bubble was supposed to collapse last year as the Fed tapered its quantitative easing and rates increased, recalls Allan Roth, founder of financial planning firm Wealth Logic, in an article for Financial Planning. Bond values dropped some last year, but bounced back this year.

Bond funds are "laddered" portfolios, he explains. As rates rise, lower-yielding bonds are replaced by higher-yield ones. Returns will ultimately increase as long as you don't panic and sell.

Bubbles can happen only to risky assets, Roth argues. While bonds lost 2 percent last year, stocks lost that much on several days this year.

"Never forget that stocks are riskier in a day than high-quality bonds are in a year. The role of the bond portion of a portfolio is that of a shock absorber. Fear of bond bubbles shouldn’t drive your asset allocation."

Editor's Note: 250% Gains Bagged Using Secret Calendar (See Video)

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Bond investors must strive to protect themselves from a likely bond bubble, urges CMG Capital Management CEO Steve Blumenthal.
Blumenthal, bond, fund, rate
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2014-41-27
Tuesday, 27 May 2014 12:41 PM
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