During the credit crisis and subsequent global recession, governments around the world cut key interest rates to record lows and enacted massive stimulus programs with the hope that they would stabilize – and later jump-start – their economies. Here in the U.S., the Federal Reserve’s quantitative easing programs have kept interest rates in the basement and allowed stocks to surge.
Given all of the stimulus, investors have been certain that inflation and interest rates would have to rise sooner or later. As such, inverse treasury ETFs such as the ProShares UltraShort 20+ Year Treasury (NYSE Arca:TBT) and short-duration bonds have become popular investment destinations.
But until that day of rising rates arrives – and some analysts predict that this event might not happen for a very long time – long bonds could be a great place to park your money in 2014.
A Weak Global Economy
While short-term and low-duration debt garnered plenty of investor attention last year, as they offer protection from rising rates, the current environment may be better suited for longer-dated debt. Bullish tailwinds should favor long bonds for the rest of the year.
To start, the global economy isn’t exactly rocking.
Tepid economic conditions and lack of inflation have many believing the Fed will hold off raising its benchmark overnight interest rate for a long time. That rate determines what investors earn on savings accounts, CDs and money market products such as the iShares Short Maturity Bond ETF (BATS:NEAR). With those products still paying essentially zero, investors will be starved for yield for quite some time. In fact, the ideas of deflation and stagflation have been tossed around by economists lately. Those two scenarios make long bonds the perfect portfolio addition.
Meanwhile, concerns about stalling growth and currency issues in emerging markets have investors looking for safety in U.S. Treasury bonds. Add in a possible war in the Ukraine, and the case for long bonds gets even better.
The idea of finding safety comes in on another front as well.
After a torrid 30%-plus run in the stock market last year, many pension funds and insurers have begun to dial back risk by returning to the safety of U.S. Treasuries and investment grade corporate bonds. More importantly, many pension funds and insurers prefer longer-dated bonds which better match their liabilities.
A Bet On Long Bonds
Considering the potential sideways movements in the market over the rest of the year, adding a touch of long bond exposure to a portfolio might be a good bet. Already, long-term Treasury bonds – those with a maturity of 25 years or more – have delivered a total return of 10% so far this year, according to research by Barclays (NYSE:BCS). More gains could be in store and there are several avenues for investors to pursue in order to get that exposure.
With safety in mind, longer-termed treasuries could be a great bet. With more than $4.1 billion in assets, the iShares 20+ Year Treasury Bond ETF (NYSE Arca:TLT) could be investors' first stop. The ETF tracks 23 different U.S. government-issued bonds and has an average maturity of 27 years. That produces a 3.23% yield. Another plus is that TLT features a rock-bottom expense ratio of just 0.12%. Investors can also use the SPDR Barclays Long Term Treasury ETF (NYSE Arca:TLO).
Companies have been taking advantage of investors' thirst for long-dated bonds as well. Recently, Peoria, Ill.-based heavy machinery specialist Caterpillar Inc. (NYSE:CAT) issued 50-year bonds. That deal was snatched up investors. For more diversification (1,300 different bonds) with a better yield than Treasuries at 4.56%, the Vanguard Long-Term Corp Bond Index ETF (Nasdaq:VCLT) could be a prime pick.
Finally, for ETF investors looking really long, Treasury STRIPS and zero-coupon bonds could be the way to go. These bonds are sold at a significant discount to face value and offer no interest payments because they mature at face value. Both the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSE Arca:ZROZ) and Vanguard Extended Duration Treasury Index ETF (NYSE Arca:EDV) offer an easy way to play these complex, fixed income bonds. Both funds have rallied so far this year.
The Bottom Line
While everyone is certain that interest rates will have to rise this year, that prediction hasn’t come true yet. In fact, there are several bullish catalysts that say that we could be in for low rates for a long time. That means the long bonds may be a prime place to park your money in 2014.