Although the bond market has stabilized since the beginning of the year, the recession continues to promise further volatility, says Doug Swanson, manager of the JP Morgan Core Bond fund. "The economic fallout doesn't seem to be as bad as some people thought it would be initially, but it's going to take a couple of years for things to really start turning around," he says.
He takes a similarly guarded view about future fund performance. "People shouldn't buy a conservative fund like this and expect considerable price appreciation, especially in this environment. But it is reasonable to look at the yield of the fund and anticipate a similar total return over a longer time horizon." As of early June, the SEC 30-day yield stood at 5.35%.
An uncertain economy would not necessarily be bad news for the JP Morgan Core Bond fund. Indeed, it might prompt investors to gravitate toward investments seen as safer, including the government-backed securities and investment-grade bonds Swanson's been focusing on since he took the helm of the fund nearly 17 years ago. Since March, though, the bond market's more aggressive corners, such as high-yield bonds, have shot ahead as investors become more comfortable taking risk to achieve unusually high yields. Through June 5, high-yield bond funds delivered a year-to-date total return of 21.61% and bank loan funds jumped 23.87%, according to Morningstar. More conservative intermediate-term government bond funds, which are typically loaded with Treasury securities, remained flat. The JP Morgan Core Bond fund, meanwhile, has crept up just a few percentage points.
This year's performance dispersion among bond market sectors represents an about-face from last year, when shell-shocked investors fled anything that had even a whiff of risk and moved into ultra-safe bonds such as Treasurys. As investor appetite for risky securities has grown in 2009, however, the prices of 10-year Treasury securities have fallen while yields have risen from a little over 2% in December to 3.85% at the beginning of June. At the same time, junk bond prices have shot up and yields have dropped, compressing the yield spread between the two ends of the fixed-income credit quality spectrum. Meanwhile, the yield premium on mortgage-backed securities has also evaporated-from about 3% over Treasurys to about 50 basis points over-as the government plans an intervention to shore up MBS prices and assure investors the market will not implode.
The market was initially skeptical of early policy statements by the new administration, says Swanson. But the Treasury's announcement of its Public-Private Investment Program (PPIP) and its announcement that it would purchase agency mortgage-backed securities helped calm jittery investors. PPIP will use $75 billion to $100 billion in Troubled Asset Relief Program (TARP) money and capital from private investors to buy $500 billion to $1 trillion of toxic assets off the books of banks.
"The improvement in the mortgage-backed securities market this year," says Swanson, "shows investors are confident that the federal government will do everything possible to stand behind the Fannie Mae and Freddie Mac securities."
Whether investors will move toward riskier junk bonds or back to the shelter of safe, secure Treasury and government-backed securities depends largely on how confident they feel about the economy. Consumer confidence is rising to its highest levels since last fall, notes JP Morgan chief market strategist David Kelly, while manufacturing activity and home sales are showing signs of life. Most major financial institutions reported profits for the first quarter of the year following the huge write-downs of 2008.
On the other hand, the U.S. may still see barriers to economic growth, such as high unemployment, a possible spike in oil prices, tight credit conditions and a possible renewed financial crisis stemming from problems in commercial real estate.
"It is still too early to call an economic turning, point," says Kelly. "The unemployment rate continues to rise, housing starts and vehicle sales have yet to make a definitive move upwards and investment spending is still slumping."
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Swanson won't opine on where he thinks the economy is headed, preferring to leave the job to economists at his firm. He also won't comment on whether investor taste for risk will continue to sharpen this year, which would favor junk bonds over the securities in his fund's more staid portfolio.