A bond-fund cushion can soften market ride

The case for bonds - relative safety, steady income streams, return of principal - is as timely as ever, despite the latest surge in the US stock market.

For the fourth quarter of 2000, virtually all US bond-fund categories posted sizable gains, according to financial information firm Lipper Inc. The roster was led by US Treasury funds, which were up 6.25 percent.

For the full year, Treasury bond funds again led the pack, up 17 percent. And all major bond-fund categories posted gains, with the exception of high-yield (junk) bond funds, which were down for the year.

The strong showing by bonds was in sharp contrast with equity mutual funds, where the average fund, according to Lipper, lost about 1.7 percent.

But what a difference a day can make. Early last week, the US Treasury market shot up in a giant rally. Why not? Bonds are the place to go when stocks are in the doldrums, as they were that day.

But then came Wednesday, when the Federal Reserve unexpectedly slashed a key interest rate by one half of a percentage point. That move sent the stock market into the stratosphere. But it also yanked the rug out from under the prior day's gains for the Treasury bond market. Treasury prices plummeted, as the stock market soared. Long-term Treasuries posted their largest price declines in nine months, sending shock waves through much of the bond market, which in terms of dollar value is far larger than the stock market.

For bond-fund investors, the question is: Should you stick with fixed-income products now or move into stocks?

First, don't do anything rash, says Rollin Williams, a managing director with Evergreen Institutional Asset Management, in Charlotte, N.C. A one- or two-day rally, he suggests, is hardly proof of a resurgent stock market.

Mr. Williams, who oversees a little more than $2 billion in fixed-income products, calls himself a "long-range" manager. While he feels the bond market got "a little ahead of itself" early last week, he sees no reason for bond investors to change their strategy.

He favors long-term issues over short-term or intermediate-term bonds. And he finds more meaningful options in US Treasury and mortgage-backed products than corporate issues. Uncertainty over corporate earnings in the fourth quarter has made it difficult for his firm's analysts to determine a bond's credit risk, he says.

While Williams rejects the notion of scuttling one's bond holdings to leap aboard the equity bandwagon, some economists believe bond investors should at least re-examine their fixed-income portfolios.

"Treasuries are overvalued," says Sung Won Sohn, chief economist for Wells Fargo & Co., Minneapolis. "The key assessment now is that we will not have a recession, but some type of soft landing," he says.

Given that assumption, the prudent course, says Mr. Sohn, would be to shift assets out of Treasuries to municipal bonds, US agency issues, and quality grade corporate bonds. Sohn would also shift some assets out of bonds and back into equities.

Sohn expects additional rate cuts by the Fed, with the total rate reduction eventually reaching over a full percentage point. Each cut, he says, should boost equities markets.

Still, given uncertainties about the overall economy, and direction of the equities market, bonds retain their distinction as products of relative safety.

In the case of bond mutual funds, experts agree, investors should seek funds with successful records and low expense ratios (well below 1 percent). In the case of fixed-income products, gains are often minuscule.

If you choose to buy individual bonds, "go to your friendly broker," says Williams, and ask her to check out her "odd lot" list of available issues in the $10,000 range, such as mortgage issues, or quality corporate products.

(c) Copyright 2001. The Christian Science Publishing Society

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