Riskier Bond ETFs Are Still in Favor

As we pointed out in our previous article, one can vary along three dimensions in fixed income investing: Interest rates (long vs. short maturity), credit (high yield or junk vs. investment grade) and international (vs. domestic). The following table shows the trend scores across various bond ETFs.

Assets Class	Symbols	01/28 Trend Score	01/21 Trend Score	Direction
High Yield	JNK	4.06%	4.49%	v
International Inflation Protected	WIP	2.58%	3.41%	v
International Treasury	BWX	1.25%	1.89%	v
Long Term Credit	LQD	0.99%	0.76%	^
Intermediate Term Credit	CIU	0.92%	1.0%	v
Short Term Credit	CSJ	0.71%	0.45%	^
Inflation Protected	TIP	0.49%	0.14%	^
Short Term Treasury	SHY	0.3%	0.2%	^
Intermediate Treasury	IEF	0.26%	-0.32%	^
Emerging Mkt Bonds	PCY	0.12%	0.47%	v
Treasury Bills	SHV	0.02%	0.01%	^
US Total Bond	BND	-0.07%	-0.31%	^
10-20Year Treasury	TLH	-0.71%	-1.38%	^
MBS Bond	MBB	-1.09%	-1.1%	^
National Muni	MUB	-1.98%	-2.79%	^
New York Muni	NYF	-2.14%	-3.14%	^
20+ Year Treasury	TLT	-2.95%	-3.17%	^
California Muni	CMF	-4.61%	-6.54%	^

The trend score is defined as the average of 1,4,13,26 and 52 week total returns (including dividend reinvested).

From the table, the riskier bond ETFs are still in favor: High yield (JNK) is ranked at the first place and international inflation protected government bonds (WIP) and international Treasury (BWX) are in the second and third places respectively. On the interest rate side, things are getting murky: On one hand, long term Treasury bonds (TLH, TLT) have been weak while long term investment grade corporate bonds (LQD) is still ranked at the fourth place. Let's analyze these in more details.

High yield (junk) bonds (JNK, HYG): In the current low interest rate environment, with governments around the world being determined to simulate the economies, high yield bonds bode well with the economy recovery phase. The downside: Elevated stock market valuation and extremely small credit spread (high yield vs. investment grade) might signal a correction in the short term.

International bonds (WIP, BWX): Long term dollar weakness translates into better international bond prices. This has been helped by Federal Reserve Quantitative Easing 2 (QE2). Short term, the dollar strength (or stock market correction) could very well signal the upcoming weakness of international bonds. International inflation protected bonds (WIP) has more than 35% eurozone bonds, more than 18% UK and 4% Japan bonds (all holding data of WIP are on 1/28/2011, form the SPDR fund page). Since inflation in Europe in general is still out of sight, WIP is somewhat muted with its emerging market inflation protected bond holdings.

Long term bonds (LQD, TLH, TLT): Though the long term Treasury bonds have dropped a bit (TLT, for example, has dropped 8.17% in the last 13 weeks, refer herefor more details), they currently seem to find their supports. Again, as we pointed out before, the long term bond yield cannot be too high at the moment since that will increase long term borrowing cost (such as home mortgage rates) and thus will have negative impact on the economy. Traditionally, long term Treasury bonds will act as a hedge during stock market downturns.

To summarize, the bond markets are in flux: Short term, riskier bonds like high yield and international bonds are still in favor, though a market correction can bring these down. On the other end, high quality credit bonds and long term Treasury bonds will act as hedges if there is a stock market (or riskier assets) correction. Investors who concur with the economic recovery theme should ride on the high yield and international bonds with caution.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.