Most new investors are somewhat familiar with stocks and the events that cause their prices to go up or down. A company comes out with a great earnings quarter, and the stock moves up 5%. Great! Everyone makes money (except the short traders). When earnings season is delivering negative news, for instance with what we are currently seeing with revenue expectations for early 2013, well we get a decline. Additionally, the looming fiscal cliff issue that lawmakers are having to negotiate, will also have a significant impact on the immediate direction of the markets.
What can we do to keep our portfolios marching upward, in the face of a potential market correction? We can diversify. And one way of doing that is to buy bonds. 30, 20, and 10 year Treasury Bonds are common US government bonds, and are the most popular and stable in price fluctuations. Corporate bonds issued by large, well-established companies that are profitable are also relatively stable in a declining equities market.
Now, I know most of you think that bonds are boring and don’t have the same sexiness of the momentum stocks we hear about in the news. But unless you have the timing and attention required to short trade a stock, you can safely purchase bonds to maintain, and even increase your portfolio’s value as the bottom is falling out from underneath us. As money is flowing out of equities and the markets are declining in big numbers, bonds are being bought up in large numbers. Although this drives up the bond price, it inversely drives down the yield (which I will discuss in another post). That is how we, as simple investors, gauge the flow of money in and out of the bond markets. Something to watch as we try and get a leg up in this game.
So to understand how this price correlation transpires, I suggest you watch the movement of the iShares 20+ year Treasury Bond ETF (TLT). This ETF is a large fund, that invests in long term US government bonds, with a duration greater than 20 years. As the stock market was declining after Obama’s election, TLT was doing just the opposite. It closed out election week with a modest 3.5% gain. Not too bad when the S&P lost 2.8% during the same trading sessions. A much safer trade when compared to the ultra short leveraged ETFs that a lot of traders try and play during big pullbacks, where bad timing can get ugly really fast.