Tuesday, September 24, 2013

Capital Outflows from Bond Funds Near Record, Bond Bear Market Keeps Growing

By now you have caught on that interest rates have risen, and they appear poised to keep testing higher yields. With the 10-year Treasury yield so close to 3% and the 30-year Treasury so close to 4%, history indicates that these certainly will be tested. As interest rates have now risen well over 100 basis points since the start of May, investors are bailing out of bond funds at a breakneck pace. Independent research service TrimTabs shows just how bad the carnage is: bond mutual funds and bond exchange-traded funds (ETFs) have redeemed a whopping $30.3 billion so far in August.

You are seeing a very large capital exodus by any stretch, particularly when you consider that the reading measured was only through August 19, leaving another week and a half before the month is finalized. TrimTabs showed that this month's outflow is already the third-highest on record, and it now tallies up to a whopping $114.1 billion in redemptions since the start of June.

Prior to June, TrimTabs represented that bond funds had posted capital inflows for 21 consecutive months. The record month of outflows was the $69.1 billion in June, and July saw an outflow of $14.8 billion. TrimTabs warns that the Fed’s tapering risk may be more disruptive than most market participants believe. Here is how TrimTabs puts this figure into context, and it is a truly massive figure:

The record inflows into bond funds in the previous four years likely account for the intensity of the recent redemptions. A staggering $1.20 trillion poured into bond mutual funds and exchange-traded funds from 2009 through 2012. Many investors probably didn't grasp the interest rate risk they were taking. Now that they're suffering losses in funds they regarded as "safe," they want out fast.

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Capital outflows have been heaviest in municipal bonds and Treasury bond funds. The municipal bond mutual funds TrimTabs tracks daily posted an outflow of $2.1 billion (2.3% of assets) in the past month, while municipal bond ETFs redeemed $199 million (1.7% of assets). Treasury bond mutual funds tracked posted an outflow of $3.4 billion or some 1.8% of assets in the last month, while Treasury bond ETFs redeemed $1.9 billion or 0.5% of assets.

Here is what we would be concerned with. If $1.2 trillion in new capital poured in from net inflows over a four-year period and only $114 or so billion has come out in three months, then this bear market in bonds still has quite a ways to go. A 3% yield on the 10-year may have to rise to 3.50% or even 4%, and that 30-year yield at almost 3% may have to rise to 4.5% or even 5%, if history is any great yardstick.

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