What To Make Of Corporate Bonds Now

As I’ve made clear plenty of times before … I consider solid dividend-paying stocks to be the best long-term income investments on the planet.

But I also keep a watchful eye on other asset classes, including the various flavors of bonds.

That’s because bonds both compete with dividend stocks for investment dollars and can also afford an income portfolio with healthy diversification.

If you’re a Dividend Superstars subscriber, you know that I often talk about bonds in your monthly issues. But the last time I mentioned them here in Money and Markets, was back in May.

My conclusion then: I said it looked like a good time to start nibbling on various categories of corporate bonds.

The basic premise was that yields looked relatively good, and the idea of above-average defaults was already baked into the cake.

I also felt that corporates were certainly a better way to go than Treasuries at the time.

Since Then, Nearly All Classes of Corporate Bonds Have Produced Good Returns for Investors …

As you’d expect, the returns have run the gamut from “decent” to “pretty darn good for bonds!”

For example, you might recall that I said Vanguard mutual funds were an easy and cheap way to play individual bond classes.

Here’s how some of the funds I mentioned have performed since that column on May 5:

Vanguard’s Intermediate-Term Corporate fund (VFICX) has gained about 10 percent …

And the Vanguard High-Yield Corporate fund (VWEHX) is up about 8 percent.

Remember, these are bond funds. You don’t normally expect 5 percent or 10 percent returns in just a few short months.

What’s more, I am not even counting the yields. That’s why most people buy bond funds in the first place!

So What Do I Think Now That This Rally Has Happened?

After the runup in these funds, yields have come down substantially.

For example, the VFICX now has a yield of 4.63 percent and the VWEHX yields 8.5 percent. The first time I mentioned the VWEHX in Dividend Superstars - in March - it was yielding more than 11 percent!

In short, I can no longer say it’s a great time to be committing a lot of new money to these funds.

That doesn’t mean I think they’re overpriced, just more fairly valued. You could certainly continue dollar-cost averaging into them, or at least reinvesting your current payments as a way of building a bigger position.

After all, if the economy does continue to stabilize, I would expect additional upside, particularly from corporate and junk. But my point is that these categories are no longer screaming bargains.

As far as inflation-protected bonds like TIPs … I remain positive on them as a great way to hedge against a future inflation shock.

I’ve been saying it often, but the Fed is really walking a major tightrope at the moment. They need to keep pumping in money to stabilize the economy … but they’re risking serious inflation down the line.

One minor slip-up in their exit strategy and things could get out of hand quickly.

For all these same reasons, I am still negative on longer-dated U.S. Treasuries. Like Mike Larson, I remain concerned that we have only seen the beginning of a bursting bubble in government bonds.

A crack in that market would send rates up sharply. And only then would I recommend starting to build a substantial position in longer-duration Treasuries.

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