In short: All bonds are not equal
Just a quick note to let investors know a rising-rate environment doesn’t translate into “Get out of bonds.’’ In fact, credit-oriented bonds, i.e., high-yield and investment-grade corporate issues, stand to benefit from the strengthening economy that’s behind the recent move up in longer yields—a move precipitated by the Fed’s acknowledgement that it may soon begin to taper monthly bond purchases precisely because it’s feeling better about the economy. As with equities, credit-oriented bonds derive a share of their value from individual corporate performance. This is why the high-yield market has been able to generate positive total returns so far in 2013 while high-quality bond benchmarks including U.S. Treasuries are well into negative territory. Longer-term Treasuries are extremely sensitive to changes in rates, making them vulnerable and a large underweight in Federated’s model stock-bond portfolios. But what’s bad for Treasuries can be good for high-yield—as Treasury yields rise, the gap (or yield spread) between high-yield bonds and comparable maturity Treasury bonds typically narrows, helping to cushion the impact of rising Treasury rates. This helps explain our recent decision to bump up the high-yield allocation in our model stock-bond portfolios to maximum overweight.