Your Money Matters

By Gregory Zuckerman

June 17, 1998

Bonds are charging ahead and interest rates are dropping, buoying all kinds of borrowers -- from homeowners and some credit-card holders to corporate treasurers and the U.S government itself.

But is the decline in interest rates already over? The answer, many analysts say, is no.

Even as stocks have tumbled recently amid Asia's troubles and worries about U.S. corporate profits, bond prices have roared -- meaning their yields, which move in the opposite direction of prices, have slid more and more. In fact, bonds, especially stodgy Treasury securities, are suddenly all the rage, as the locked-in yields a holder of these bonds can expect -- for as long as they're held -- draw investors world-wide.

In the past month, the yield on the 30-year Treasury bond, the market's benchmark, has fallen as low as 5.58% on Monday, the lowest level for comparable long-term bonds since the 1960s and early 1970s. Yesterday, bonds slipped, sending the yield on the bellwether bond up to 5.65%. But yields are still down sharply from 6.70% a year ago.

Boon to Borrowing

The tumbling yields are giving home-owners, and prospective homeowners, a shot in the arm. Because yields on 30-year and I0-year Treasury bonds have fallen so far, new homeowners are enjoying the lowest mortgage rates since 1993, and existing homeowners are rushing to refinance their mortgages to take advantage of the low rates.

Meanwhile, the nation's companies and municipalities are issuing debt at a record pace, and the Treasury is saving a bundle selling bonds at lower rates.

But what is the average investor to do?

Analysts tend to believe that the bond-market rally of the past month is going to be hard to match in coming months. But long-term investors keen to reduce the volatility of a portfolio of stocks will find a haven in bonds, especially if they hold them to maturity. Indeed, stock-market turmoil in the U.S. and abroad already has driven many investors to bonds. Beyond stability, bonds currently offer a historically high return relative to the rate of inflation and there still remains a chance to capture more capital gains if bond prices climb higher, as some analysts suggest they will.

"It's not too late for investors who want to get into bonds," says Marilyn Cohen of Envision Capital in Los Angeles, who works with smaller investors.

"At best, stocks will go sideways the rest of the year and bonds should be at least competitive, if not outperform," argues James Bianco, the director of research at Arbor Research & Trading, in Barrington, III.

Tolerance of Risk

The question confronting individual investors is how much risk they're willing to take in what should be a safe investment. Long-term bonds such as the Treasury's 30-year issue offer higher yields than shorter-term bonds, but not much. For example, a two-year Treasury note yesterday was yielding 5.48%, compared with the 5.65% offered by the 30-year bond. Two-year notes by their nature are far less volatile than 30-year bonds. That means an investor who wants to bet that rates will fall and prices will rise would make a bigger gain on the long-term bond, assuming the bet pans out. Conversely, the investor would suffer a bigger loss on the long-term issue if the bet fails.

At the same time, short-term bonds like the two-year Treasury note offer a better yield than most bank certificates of deposit, which by their nature can't be traded. The average one-year CD is yielding 4.91%, down from 5.11% a year ago, according to BanxQuote Inc., a financial information service. Still, there are some attractive CDs out there: The highest rate available, according to BanxQuote, is 6.10% at the Atlanta Internet Bank, and larger accounts can often negotiate higher rates.

Money-Market Funds

Money-market funds may be an attractive alternative to both bonds and certificates of deposit. The average taxable money-market fund is yielding 5.12%, unchanged from a year ago. These funds invest in short-term Treasury bills and corporate commercial paper and offer an additional advantage: They are easily bought and sold, even to the extent that many funds offer check-writing privileges to account holders.

If bond prices fall, and rates rise, money-market rates will also jump. Diligent investors can even find money-market funds with payouts that exceed those of bonds. Strong Step I money fund, for example, sports a yield of 5.83% and accepts investments starting at $1,000.

"Investors have to ask themselves if they want to be heroes and take a chance on the capital appreciation of bonds," says Peter Crane, an analyst at IBC Financial Data. "Income-conscious investors may need the slight yield advantage in bonds, but retail investors shouldn't be speculating on interest-rate moves."

Bonds and Bond Funds

Bond funds have a certain attraction, but buying a bond fund isn't the same thing as buying a bond. Bond-fund managers are constantly adjusting their portfolios to maximize both interest payments and capital gains. Thus, bond-fund holders can't rely on regular fixed-interest payments, as they can If they hold a bond directly. Given the recent bond rally and the simultaneous drop in stock prices, bond funds are going to look extremely attractive in the next few weeks. But investors need to remember that if interest rates reverse course and start rising, bond-fund performance will suffer from capital losses even though their interest payments will rise along with rates.

Tax-free municipal bonds remain the best deal in bond land, especially for high-income investors. A surge in issuance of muni bonds this year has driven down their prices, and many trade at bargain levels. Further, because many issuers already have sold bonds this year, analysts expect muni-bond issuance to die down, which would tend to boost prices of existing issues.

"Munis have lagged Treasurys and are an excellent buy," Envision Capital's Ms. Cohen says. "They're ideal for an investor who wants an income stream and you can get a good quality muni with a 4.2% yield, which works out to 6.95% for people in the top tax bracket. If that sounds a little conservative, it's supposed to."

The yield on many corporate bonds is beginning to look attractive, but that's an area that many experts suggest individual investors should avoid. Some corporate issues, especially bonds rated as junk or medium- and lower-quality, have been hit hard recently by investor concerns about corporate profits. If an investor is willing to make a bet on corporate earnings, that bet might as well be made through the company's stock rather than its bonds, some experts say.

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