Sunday, May 5, 2013

Why the Dow's Rise Hasn't Hurt Bonds

Today's big jump for the Dow Jones Industrial Average (DJINDICES: ^DJI  ) , which was up 166 points as of 1:10 p.m. EDT to trade just shy of the 15,000 level, is just the latest in a series of all-time record highs for the popular stock-market benchmark. Yet even more surprising than the long run of records for the Dow is the fact that it hasn't done much damage to the bond market, which continues to advance in a long bull market that, by some measures, has lasted more than 30 years.

Today, the bond market did see price declines, as the favorable news on the employment front raised expectations about the overall economy and thereby led bond investors to conclude that the Federal Reserve might end up raising short-term interest rates from their rock-bottom levels sooner than initially thought. Earlier this week, following more dour economic news, some believed that further easing -- that is, quantitative easing -- might be necessary. That now looks far less likely.

Over the past year, however, bonds have largely held on to their gains despite the stock market's impressive performance. The iShares Core Total US Bond ETF (NYSEMKT: AGG  ) is up almost 4% since this time last year, reflecting the low-interest-rate environment but also managing to produce some capital appreciation on top of the interest payments its bonds generate. Those who have expected long-term interest rates to spike higher have been sorely disappointed: The bond-bearish ProShares UltraShort 20+-Year Treasury ETF (NYSEMKT: TBT  ) has lost almost 20% of its value since this time last year.

Whether interest rates can stay low in the future depends on whether readings on the economy continue to improve. If business activity starts to pick up more, then the need for low interest rates to spur borrowing should disappear. Yet with companies having increasingly turned to leverage as a way to produce higher income, the Federal Reserve will have to be extremely careful in engineering a retreat from its zero-interest-rate policies in order to avoid unintended consequences that could spook the bond market at just the wrong time. If that were to happen, it could easily bring both the bond market and the stock market down in concert, just as they've risen together over the past several years.

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