Money managers are set for bond market crash.
A popular topic among pundits and the mainstream financial media has been the bond market’s liquidity or its non-liquidity, as the case may be. The world has suddenly been awaken to the fact that yield-hungry investors may be facing a disaster in shrinking dealer inventories.
Bonds in smaller, less-traded markets are beginning to fall out of favor. With the Federal Reserve’s beginning to raise U.S. interest rates, investors want to know they can sell their investments quickly in the event the debt markets turn volatile.
Furthermore, professional market participants are making the underlying markets even more illiquid by actively avoiding credit markets and resorting to derivatives.
However, one way to alleviate risk is to simply move to cash, a strategy that several money managers are currently implementing in order to ensure they aren’t one of the investors left holding the bag after the bond market crash.
Bond funds are being very defensive, They’re holding about 8 percent of their assets in cash-like securities, the highest proportion since at least 1999. The reasoning behind this is that the Federal Reserve is moving toward its first interest rate increase since 2006.
The belief is that the end of record monetary stimulus will rattle the herds of investors who invested cash into risky debt to try and get an impressive yield.
Of course, the U.S. central bankers are trying to gently wean markets and companies off the current zero interest rate policies. Their idea of an ideal scenario is that the cost of borrowing will rise slowly and steadily, debt will calmly absorb the losses and corporate America will easily adjust to debt that’s a little less affordable amid an improving economy.
However, this outcome seems less and less likely as volatility in the bond market climbs. If you alter the markets for long periods of time and then you remove those alterations, you will subject the market to severe unanticipated volatility.
Additionally, record-low yields have prompted investors to pile into the same types of risky investments as they had in the past, so it may be an even bigger problem to get out when sellers will overwhelm a few buyers.
These, however, are all concerns of mutual fund managers, hedge-fund managers and other large speculators who have enjoyed a bull market in bonds for more than 30 years. An expected bond market crash and volatility will actually provide a buying opportunity for long term investors who will be able to buy bonds at deep discounts and hold them to maturity.
What should retail investors do to prepare for what’s coming next in the changing markets? Unwind all of your holdings in bond funds. Build a portfolio of high quality corporate and municipal bonds with short and medium term maturity (2-5 years) and reserve some cash for bargain purchases during an expected bond market crash.