What are Bond ETFs Trying to Tell Us (and How Can You Profit)?

Okay, true confession time: I watch the bond market like a hawk. Nothing fascinates me more than interest rates.

That may not make me the most exciting cocktail party guest. But it has helped me make or save investors a hefty chunk of change more than once.

That brings me to the extremely odd action I’m seeing in bonds today. Take a look at this Weiss Ratings Screener I built called Bond ETFs in 2017. It shows the performance of several ETFs that track different parts of the bond market, as well as the SPDR S&P 500 ETF (SPDR, Rated “B”) and the iShares Russell 2000 ETF (IWM, Rated “C+”) for comparison’s sake:

Data Date: 6/7/17

You can see that the S&P 500 is actually underperforming one bond ETF, the SPDR Bloomberg Barclays Convertible Securities ETF (CWB, Rated “B-”). That fund invests in so-called convertible bonds, which are hybrid investments that share characteristics of both stocks and bonds. It’s up 10.1% year-to-date, compared with a 9.4% gain for the SPY.

Meanwhile, the plain-vanilla iShares 20+ Year Treasury Bond ETF (TLT, Rated “C”) is right on the SPY’s heels with a return of 6.1% year-to-date. So is the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB, Rated “C+”) at 7.1%.

As for the small cap-heavy IWM, it’s underperforming them all. Heck, small caps aren’t even beating one of the most boring investments on the planet, municipal bonds! The iShares National Muni Bond ETF (MUB, Rated “C”) is up 3.6% year-to-date, versus a 3.3% gain for the IWM.

I can’t even begin to tell you how weird this is. When stocks are having a solid year like they are in 2017, government bonds tend to either underperform or outright lose money.

After all, investors are making a statement when they invest in stocks. They’re saying they expect decent economic, earnings, and sales growth – and therefore, they’re willing to move money out of risk-free assets (Treasuries) and into riskier ones (stocks). But as I just showed you, both TLT and SPY are doing well.

It’s not just a U.S. phenomenon, either. Foreign stock markets are performing very well, with the Vanguard FTSE All-World ex-US Index Fund ETF Shares (VEU, Rated “C”) up 15.5% YTD. But the foreign version of the TLT, the iShares International Treasury Bond ETF (IGOV, Rated “D+”), is also up a respectable 6.5%.

When stocks surge, you also typically see riskier corporate bonds do very well. That’s because both stocks and high yield, “junk” bonds are bets on strong earnings growth and an increasing ability to repay debt. Lower-risk, higher-grade corporate bonds, on the other hand, tend to underperform along with Treasuries as money rotates into riskier assets.

But look at the gains for the higher-risk iShares iBoxx & High Yield Corporate Bond ETF (HYG, Rated “B-”) and the lower-risk iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD, Rated “B-”). They’re virtually identical at 4.5% and 4.3% respectively.

Then there’s this: When high-yield bonds do as well as they are in 2017, small caps typically turn on the afterburners. That’s because high-yield bonds and smaller-cap stocks are both investments with a higher-degree of risk. Yet the IWM is lagging behind the HYG, and badly lagging behind the SPY. Even government bonds are returning almost twice as much!

Like I said earlier, this just isn’t “normal” behavior. Not only are stocks and bonds “disagreeing” about the outlook for economic growth and risk appetite. So are different classes of bonds.

So what does this all mean to investors like you? Well, bonds have historically gotten things “right” more often than stocks. The bond market sent out early warnings of the housing market crash in the mid-2000s, and the energy market meltdown a few years ago. If you heeded the message from bonds, you would’ve dumped a ton of stock exposure – and saved yourself a boatload of money.

But right now, junk bonds and Treasuries are sending out conflicting signals. So are stocks and bonds. So my best advice is to avoid taking any rash steps, and let the markets sort this out.

Or in practical terms: Dial down your stock exposure a bit in light of the conflicting signals we’re seeing. But don’t make a mad dash for the exits until the credit markets start warning you to.

Plus, this market is tailor-made for investing in higher-yielding bonds AND stocks because they’re both performing very well. That’s the focus of my brand-new investment newsletter, so keep your eyes on your email for all the juicy details. I couldn’t think of a better time to invest in the recommendations it will contain.

Until next time,

Mike