Is the Bond Market as Disconnected from Reality as the Stock Market?

Everybody is wondering how the stock market can be so high while the U.S. economy is so low. But you don’t hear the same rumbling concerns about the bond market – even though something very similar to ultra-high P/Es is going on in the fixed income side of your portfolio.

Recently, the Barclay’s AGG index, which is the most common index tracked by ETFs, was yielding roughly 1.07% with a duration of six years – meaning, in layperson’s language, that if interest rates were to rise 1%, the ETF investors would lose 6% in price terms. This is a horrible risk/return profile.

But what are your alternatives for the fixed income segment of client portfolios?

Recently, I moderated a discussion with three professionals who constantly monitor the bond market from very different angles. Part of the conversation took place in a webinar, part of the Insider’s Forum conference’s “Three for Free” summer series. The rest of it came in preparation and supplemental interviews.

How different were the perspectives? The conversation included Eddy Vataru, chief investment officer of the total return strategy and portfolio manager at Osterweis Capital Management in San Francisco. Vataru worked with the Treasury Department in 2008-9 on its TARP program, trying to help stabilize the mortgage market while working as a senior staffer at Barclays Global Investors (now Blackrock), so he has seen the stimulus efforts from the inside and closely follow the Fed’s ever-ballooning QE programs. Vataru’s sector rotation investment strategy involves constantly evaluating the spreads at every point in the yield curve among corporates, Treasury bonds and agencies (mortgage debt), to identify sweet spots as they arise while watching the big picture developments in the overall economy.