Resolution would aid equities, hurt bonds

Everyone wants a resolution to the fiscal cliff, right? But for fixed-income investors, who have poured more than $1 trillion into the less risky asset class since the financial crash, the investments they bought as protection against equity volatility are likely to be deeply damaged by any deal. A compromise would avert a recession in the first half next year and remove a lot of the uncertainty that has been hanging over the markets. “It'd be good for businesses, it'd be very good for equities, but it'd be bad for bonds,” Ken Volpert, head of the taxable-bond group at The Vanguard Group Inc., said last Thursday at the Bloomberg Portfolio Manager Mash-Up in New York. But if the economy starts humming along at a good pace, it is likely to lead to a rise in interest rates, which the Federal Reserve has been keeping artificially low. Without the Fed's interference, rates on the 10-year Treasury note would be closer to 3.5%, double what it currently yields, Mr. Volpert said. A rise of just 1 percentage point would cause the Barclays Capital Aggregate Bond Index to lose 4 to 5 points. Still, there could be an upside to bond fund losses. Some observers predict that fixed- income losses will finally lead to the “great rotation” from bonds to equities that investors have been avoiding even though the stock market has nearly recovered all its losses from 2008. Since that time, investors have pulled nearly $500 billion from stock mutual funds. “So much money has gone into bonds and out of stocks, we're worried investors are not balanced with the right long-term asset mix they need,” Mr. Volpert said. That isn't a case to get rid of bonds entirely, of course. “You're still going to need the diversification,” said Jeff Rosenberg, chief investment strategist of fixed income at BlackRock Inc. [email protected] Twitter: @jasonkephart