Time To Run For the Bond Hills?

Has the expanding U.S. economy really been giving us signs of a significant slowdown? Granted, it would appear that many a sub-prime lender will be filing for bankruptcy and laying off employees. Indeed, there may be a number of real estate professionals – construction, banking, service – that may struggle.

Yet where are we in reality? The U.S. economy has grown more than 3% for 3 consecutive years (2004, 2005, 2006). It has done so with the threats of rising oil prices, rising interest rates, trade imbalances, rising inflation and so forth. Moreover, we haven’t seen unemployment trend higher at any point since the expansion began in 2003.

Yes, the standoff in Iran is unsettling. Yes, the housing situation will be a drag on the economy, and perhaps a bigger one that people had anticipated. Yet before investor run for the treasury bond hills, they should recognize that a bond yield of 4.5% is attractive if and only if the Fed lowers rates.

If you are getting he 4.5% annual yield, and the Fed starts cutting rates, there are bond ETFs that may appreciate in price when yields start to rise. Fixed income investing can garner as much as a 9% annual return on the Shearson Lehmann Aggregate Bond Index (AGG) if an existing holder received the 4% annual yield alongside 5% price appreciation should the 10-year treasury drop from 4.5% to 4%.

Still, many seem to forget that if and when the Fed considered lowering rates, that would occur because inflation was viewed as less of a threat than maintaining the economic expansion. And while a housing correction will remain a drag for at least a couple more quarters, there’s no denying that valuations on stocks remain exceptional. With a forward P/E of around 15 for the S&P 500 index (SPY), and earnings growth of just 5%, stocks may be fundamentally undervalued by 20%!

Disclosure statement: Some of Pacific Park’s investment clients may hold positions in any of the investments mentioned above.

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