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War booms through market

Shorter-term bonds make sense now in times of uncertainty

Wall-to-wall coverage of bombing, ground fighting and peace marches remain the intense focus of the American public.

Individual investors have become armchair students of a war in Iraq that's analyzed minute by minute by a "who's who" of retired military leaders serving as television commentators.

Those investors, however, should also be analyzing their own personal financial strategy to cope with an economically challenged world affected by the war.

No one knows for sure which way the market will go, but the reality is that a great many Americans continue to seek the safe haven of Treasury bonds and other fixed-income investments. Billions of dollars have been pulled out of stocks and stock funds this year, stashed instead in bonds and bond funds.

The problem, besides the fact that bond yields are as low as they were in the 1950s, is that bond prices decline when interest rates rise. As a result, investors who were hammered by the tech decline and three years of a bear market could be running head-on into a bond market debacle that again decimates their portfolios.

It's not that everyone should be rushing back to stocks, but rather that they should be avoiding longer-term Treasuries and other bonds of lengthy maturity. Shorter-term commitments make sense given the unsettled nature of the financial system. The Federal Reserve may need to cut interest rates again near-term, but the longer-term trend is likely upward.

"War fears have been one big reason why Treasuries have performed so well," explained William Hornbarger, fixed-income strategist with A.G. Edwards & Sons in St. Louis. "We've had a weak economy, a weak stock market and the fears about war, all of which have driven money into the safest investment in the world, the Treasury market."

U.S. Treasury securities have full faith and credit of the government guaranteeing that their interest and principal payments will be paid on time. Treasury bills mature in one year or less from their issue date; Treasury notes mature in more than a year, but not more than 10 years from their issue date; and Treasury bonds mature in more than 10 years from their issue date.

Unfortunately, there's a real chance that the bond bubble will burst, Hornbarger believes. Many newer bond investors think they've already made a sacrifice by accepting low rates but don't grasp that the accompanying risk of rising interest rates can drive down the underlying value of their bonds.

"We're making the assumption with our clients that interest rates have a greater chance of rising over the next 18 to 24 months than of declining," said Ray Ferrara, certified financial planner, president and chief executive of ProVise Management Group LLC in Clearwater, Fla. "That's why we're setting up a 'ladder' of CDs for them of six-month, one-year, 18-month and two-year durations."

Under more normal circumstances, the steps of that investment ladder wouldn't be close together in six-month increments, but instead would be a full year apart, he said.

Thinking short-term is currently painful due to record low returns. Americans once snickered at Japanese investors receiving meager yields of around 1 percent. They're not laughing now, but accepting returns in that same neighborhood from Treasury bills, short-term CDs and money market funds. Going a bit longer-term, a typical five-year CD pays just under 3 percent.

A 10-year Treasury seems more attractive at just under 4 percent — until you consider the potential for rising rates during the bond's lifetime.

"The risk is certainly toward higher rates, though variables such as the war, the threat of terrorism, the anemic economy and dour consumer confidence all need to be cleared up before rates move back to a normalized range," said Greg McBride, financial analyst with, North Palm Beach, Fla. "Rates on Treasuries and CDs will bounce around at their current record lows for a while until sentiment about future Federal Reserve action takes shape."

The Federal Reserve recently chose to leave short-term rates right where they are, at a four-decade low of 1.25 percent. Because the war in Iraq makes it difficult to obtain an accurate picture of the economy, the Fed says it will be monitoring events closely as it plans its next move.

"Investors almost have to grin and bear it because there really aren't really good rates out there," acknowledged Connie Bugbee, editor of Money Fund Report, Westborough, Mass. "My first advice to investors would be not to jump into something they may not understand, such as perhaps a junk bond fund, just to get higher yields."

One important interest rate area that doesn't cause mixed emotions these days is the housing market, where mortgage rates are at their lowest levels in more than 40 years. The mortgage refinancing crush continues due to 30-year fixed-rate loans of less than 6 percent. But even there, the war will play a significant role.

"Interest rates will depend on the war," concluded Doug Duncan, chief economist with the Mortgage Bankers Association of America, Washington, D.C. "When there's more optimism, money runs back into the stock market, out of the bond market and then interest rates rise."

Andrew Leckey answers questions only through the column. Address questions to Andrew Leckey, "Successful Investing," P.M.B. 184, 369-B Third St., San Rafael, CA 94901-3581, or by e-mail at