TREASURIES-Bonds rise on bank write-down worries

* Bank write-down, economic worries revive safe-haven bids
By Richard Leong

NEW YORK, June 1 (Reuters) - U.S. Treasury prices rose on Tuesday as fears of hefty writedowns by European banks sparked new worries about global economic recovery and unleashed demand for safe-haven bonds.

Treasuries came off earlier highs in reaction to better-than-expected U.S. manufacturing and construction data that allayed some concerns of the contagion effect on the United States from the euro zone's sovereign debt crisis.

"Treasuries and the dollar remain the safe haven because the euro zone problem will not go away any time soon," said Frank Cholly Sr., a senior market strategist at Lind Waldock in Chicago.

The European Central Bank warned on Monday euro zone banks could write down another $239 billion (195 billion euros) to the end of 2011 in the latest wave of losses stemming from the financial crisis. For more, see [ID:nLAG006303]

Concerns over another crisis in the banking sector were compounded by data signaling slowing manufacturing growth in Europe and China. In the United States, a revival in the factory sector due to overseas demand and inventory restocking has helped to lead an economic rebound over the past three quarters. For more, see [ID:nLDE6500WD]

Treasuries benefited from this uneasy and volatile climate, kicking off June in positive fashion after a solid May.

Benchmark 10-year Treasury notes US10YT=RR are up 7/32 in price according to Reuters data compared with Monday's closing levels based on overseas trading. The U.S. bond market was closed on Monday for the Memorial Day holiday.

Ten-year yields, which move inversely to price, were 3.28 percent, down 2 basis points from late Monday.

Earlier, 10-year notes were up as much as 22/32 and yielding 3.23 percent.

GOOD MAY FOR TREASURIES

Treasuries' good start in June followed their best month in more than a year. According to Barclays Capital, its Treasury total return index rose 1.71 percent last month, the biggest monthly gain since a 2.18 percent increase in March 2009.

U.S. government debt also fared better than European and Asian counterparts, which rose 1.51 percent and fell 0.84 percent, respectively, Barclays' data showed.

Bonds hung in positive territory, despite the U.S. stock market rebounding from opening losses in the aftermath of encouraging construction and manufacturing data.

In the currency market, the euro EUR= recovered from a 4-year low against the dollar in the wake of these reports. See [.N] and [FRX/]

The Institute for Supply Management said its May reading on U.S. manufacturing activity fell to 59.7 in May from 60.4 percent in April. Analysts had predicted a May figure of 59.0.

An ISM reading higher than 50 signals the factory sector is expanding. The April reading was the highest in almost six years. For more, see [ID:nEAP101100]

Meanwhile, the government reported construction spending rose 2.7 percent in April, the biggest monthly increase since August 2000. For more, see [ID:nCAT005273]

While these data suggest the U.S. economy is standing up to the crisis in Europe, investors' preoccupation with growing risks from the problems across the Atlantic remains the dominant force in moving all markets, analysts said.

"There is still tremendous uncertainty out there. As far as risk appetite, it's benign at best," said Todd Schoenberger, managing director at LandColt Trading in San Antonio, Texas.

As risk aversion lessened, the two-year swap spread USD2YTS=RR USD2YTS=TWEB -- a gauge of financial system stress -- shrank to 46.00 basis points from 46.50 basis points late Monday after widening to 52.25 basis points earlier.

(Reporting by Richard Leong; Editing by Andrew Hay)

From Reuters published on June 1 2010

How to use bonds to cut investment risk

When paired with stocks, bonds diminish risk without crimping long-run returns. Forget fancy formulas -- 60/40 or 70/30 works for just about everybody. Here’s how to get started.


By Scott Gerlach

For the vast majority of investors, bonds serve a single, overriding role -- as ballast. True, bonds function well for income seekers, and, in the hands of an adept speculator, they can beat the stock market for long stretches. But most importantly, bonds help keep a stock-focused portfolio sturdy -- steadily, predictably sailing toward long-run returns.

Bonds suffered neglect during the 1990s bull market in stocks. Investors parked ever more of their assets in equities, afraid to miss out on the rocket ride. But when the rocket crashed in 2000, stocks-only portfolios shattered. Better-diversified accounts, however, enjoyed much of the moon shot without the crash landing.
Find the right mix
The first fixed-income question for most investors is, what's the right ratio of bonds to stocks?

Michael Holland, who manages the Holland Balanced fund (HOLBX), strongly advocates a 60/40 ratio of stocks to bond for most investors. With this mix, investors can expect 80% of the stock market's long-run return but with a truly moderate level of volatility.

Holland's fund offers something of a test lab -- and wouldn't be hard to emulate. It's split almost exactly 60/40, with the stock component spread over about 20 blue chips and the bond portion almost exclusively in Treasurys, the rock-solid bonds issued by the U.S. government. (Holland's tiny fund had only $50 million under management in early 2003. His marketing consists of one Wall Street Journal ad once a year, plus annual ads in the magazines Harvard and Nantucket. He says his 2,500 or so holders never sell.)

A $10,000 deposit in Holland's fund in April 1997 (its inception) was worth $11,711 in January 2003. An identical deployment in the Vanguard 500 Index fund (VFINX) amounted to $12,162. In 2001, when the S&P 500 ($INX) index skidded 11.1%, Holland's balanced fund edged down just 0.2%.

Interested in even more security than the Holland formula offers? The minimum-risk allocation mix probably is 80% fixed-income, 20% stock, according to Alan Gayle, senior investment strategist for Trusco Capital Management. Gayle oversees investment policy for a broad array of mutual funds, and he helps manage the $575 million STI Classic Growth and Income fund (CRVAX). In his view, a 100% bond allocation would be ill-advised, even for the most risk-averse investor, as bonds can suffer lengthy bear markets of their own.

Bond allocation guidelines
Whatever your asset-allocation goal, Gayle offers some guidelines for splitting up the bond portion:

    * Start with 25% or more in bonds with as little default risk as possible: Treasurys, inflation-indexed Treasurys or municipal bonds.

    * Then add bond funds with "economic exposure," such as those focused on highly rated corporate bonds. These usually outperform Treasurys when the economy heats up. (A fund offers the diversification few investors achieve with individual corporate bonds.)

    * Don't neglect junk bonds. They deserve at least 10% of your bond investment. They correlate more closely with equities than with fixed income, and their higher yields can compensate when Treasury yields are low. Funds are the only way to play the high-yield market.

The safest bond
The safest choice of ballast material for your portfolio is Treasurys (and inflation-protected Treasurys). Only rarely do Treasurys offer the fixed-income world's biggest returns. But their issuer -- Uncle Sam -- won't be going bankrupt. Here are the best ways to buy them:

Directly from the government. The U.S. Department of the Treasury has Web site called TreasuryDirect that allows for the purchase of Treasurys. It's easily accessible to individual investors, and Treasurys can be bought at auction at no fee.

Mutual funds. There are relatively few Treasurys-only mutual funds. But some exchange-traded funds have emerged that are modeled on Treasury indexes. (Exchange-traded funds, or ETFs, are essentially baskets of actual securities that are broken into pieces for individual investors to buy. ETFs offer low fees and have certain tax advantages.) In summer 2002, Barclays Global Advisors launched three ETFs pegged to four Lehman Brothers Treasury indexes: the Lehman 1-3 year Treasury (SHY, news, msgs), Lehman 7-10 year Treasury (IEF, news, msgs) and Lehman 20+ year Treasury (TLT, news, msgs).

Government bond funds. The most common Treasury proxy is the ubiquitous "government bond fund," which usually amalgamates Treasurys, highly rated agency debt (from the Federal Home Loan Bank, Ginnie Mae and other entities) and even short-term corporate bonds. Vanguard, T. Rowe Price and PIMCO offer government funds of various durations with excellent track records. (Just be careful which class of fund shares you buy -- sales loads can be high, particularly from PIMCO.)

Simplicity is the primary advantage of these funds. Writing a check to a fund company takes less effort than buying individual bonds and can, for some investors, be worth a small annual fee. Many financial planners scorn government-bond funds, though. The problem? Few bond funds feature a single maturity date. Most managers buy and sell to take profits or pounce on perceived bargains. The only way to guarantee stability of principal is to buy individual bonds and hold them to maturity. (An exception: American Century offers a series of "target maturity" funds that hold only bonds that mature in a single year. When held until maturity, these funds closely mirror the experience of buying individual securities.)
The municipal alternative
While Treasurys tend to be the first bond category beginning investors consider, they aren't always the best option. Treasurys perform best in tax-deferred accounts, since Uncle Sam treats interest payments as regular income. And they can melt in value during periods of inflation.

One alternative: high-rated municipal bonds. These promise Treasury-like safety from default as well as important tax breaks. Buy bonds issued by municipalities in your home state, and you usually dodge federal, state and local taxes -- the "triple tax free" promise that makes munis favored income vehicles for the well heeled.

Even for the rest of us, munis make good sense. Assume you're in a hypothetical 30% federal tax bracket. A muni yielding 5% earns just as much -- after federal taxes -- as a Treasury yielding more than 7%. In early 2003, 7% Treasurys existed only in the recollections of old-timers.

"If someone were to get a fixed-income portfolio and their money were sufficient, I would think that they should own outright some high-quality municipal bonds," says Trusco's Gayle. He recommends insured or triple-A-rated general-obligation bonds.

The main problem with munis is getting your hands on them. A round lot of any particular bond goes for as much as $250,000. Buy less and you pay a higher markup. Financial planners see $100,000 as just about the smallest allocation that can go into individual munis.

Yes, you can go the mutual fund route, as muni funds accept smaller amounts. But be careful to know exactly what you're buying. "If they're going to own mutual funds, then they need to be examining the prospectus to see what the quality parameters are," Gayle says.

MSN Money offers tools for just such an examination. Start with our Top Performers screens to find consistently performing muni funds focused on your home state. Seek a low expense ratio -- it can be as little as a quarter percentage point -- and a long-tenured manager.
Tips on TIPS
While munis guard your interest from the tax man, TIPS fend off income investors' other bugaboo: inflation. Treasury Inflation-Protected Securities pay a small coupon yearly, plus their principal value is adjusted once a year to match changes in the Consumer Price Index. TIPS are cheapest when the economy is heading south and no one fears inflation. Traders hate them, but buy-and-hold investors find their inflation insurance comforting.

"It's possible sometime in our lifetime we'll have inflation again bite us in the butt," says Holland.

The downside: TIPS present tax problems. The inflation adjustment counts as income in the year it is made, even though investors don't pocket the principal until maturity. Also, TIPS are auctioned less frequently than other Treasurys. The government promises a new 10-year TIPS each July, and it reopens them for new investment in October and January.

In general, TIPS and munis move in sway with Treasurys. They make equally good ballast to counteract stock gyrations.
Reaching for yield
Money managers and investment planners debate the wisdom of sinking your entire bond allocation in low-yielding (but rock-solid) Treasurys and munis. Holland wouldn't have it any other way. But Richard Lehmann, publisher of the Forbes/Lehmann Income Securities Investor newsletter, recommends mixing it up.

Corporate bonds, junk, mortgage-backeds, mid-tier municipals and a host of other higher-yielding options abound. But it's hard or impossible for individuals to buy many of them. Minimum investments are large, and individual bonds carry exponentially more risk than a diversified bunch. Moreover, expensive research tools give professional traders huge advantages in valuing each bond's unique features -- maturity, coupon, call dates, credit rating and more. And unlike stocks, few bonds aside from Treasurys have easily accessible price histories. Fewer than 100 corporate bonds are listed on the New York Stock Exchange.

"In fixed-income investing, it is much more complicated to select the instrument you want to invest in," Lehmann says. "With common stock, everything is the same."

A typical investor seeking diversification and total return has two realistic options: Buy mutual funds or make fixed income a hobby and find a guru like Lehmann to follow. Funds encapsulate every segment of the bond market into bite-size portions, though at the price of a management fee and without a guarantee of principal. Bond newsletter writers, among whom Lehmann is the dean, make specific recommendations but leave the portfolio in your hands.

For simplicity, Trusco's Gayle suggests sticking with highly rated corporate-bond funds. He guides individual investors away from mortgage-backeds because their boom and bust cycles are less predictable. He and Holland offer a few basic rules to guide bond-fund purchases:

    * Pick a sensible credit-rating range. Moody's and Standard & Poor's use slightly different scales that appraise corporate bonds from D (in default) to triple-A (zero perceived default risk). Enter a fund's five-letter symbol in the MSN Money quote box, then click Fund Portfolio in the left-hand navigation -- the fund's average credit rating is the first data point you'll see. The PIMCO Total Return Fund (PTTAX), managed with great success by the legendary Bill Gross, has an average rating of double-A.

    * Pick a duration that doesn't make you sweat. Each bond fund has an average duration, related to (but different than) the average maturity of the fund's holdings. Duration essentially measures a bond's sensitivity to interest rates. It's given in years. PIMCO Total Return in early 2003 had an average duration of 4.4 years -- a middling number. A smaller figure offers greater defense against rising interest rates; a larger number offers more market sensitivity to declining interest rates.

    * Follow the other usual guidelines for buying funds. That means low fees, a reputable manager and a solid track record.

Regular maintenance pays off
Stocks have no ceiling. Theoretically, share prices can rise unceasingly so long as earnings expectations keep growing. But bonds run in cycles. They have ceilings -- and floors. Yields don't fall to zero or rise to infinity.

For that reason, they need to be treated differently than stocks. Watch a few different bond categories over time and you'll quickly learn to capitalize on their individual peaks and troughs. In early 2003, for instance, Treasurys looked very pricey, high-grade corporates were mending and junk bonds had come back from their 2002 collapse. Munis weren't sure what to make of a proposed cut in dividend taxes, which might lower their status among income investors.

But even before you harmonize with the bond universe, you can employ a mechanistic approach. Strike that stocks/bonds mix and rebalance to it once a year. Employ a similar approach with your bond holdings. Pare back winners and reallocate more to losers.

"It's very important not to take your eye off of the goal line," Gayle says.

You'll also have to decide what to do with the interest checks. In tax-deferred portfolios, they're best reinvested to avoid steep penalties.

In non-retirement holdings, income reinvestment helps build up bond allocations more quickly -- though you must weigh the costs and benefits. Interest is taxable in the year it's earned, regardless of whether it's reinvested. And taking income from bonds actually helps cut investment risk even further. If they get ploughed back in to principal, those interest checks are in play. Alternatively, they are beyond the market's reach once they go into cash or get used for everyday expenses.

At the time of original publication, Scott Gerlach owned or controlled shares in the following securities mentioned in this article: PIMCO Total Return.

FROM MONEY CENTRAL

TREASURIES-Bonds tumble as safety appeal hit by higher stocks

Thu May 27, 2010 12:06pm EDT

BONDS

* Yield rise may benefit 7-year notes sale

* U.S. Q1 GDP revised lower, weaker than expected (Adds analyst's quotes, updates prices)

By Chris Reese

NEW YORK, May 27 (Reuters) - U.S. Treasury debt prices fell on Thursday, with benchmark notes down more than a point as investors turned to riskier assets like stocks after China denied it was concerned about its exposure to the euro zone.

The appetite for risk rose after the Chinese central bank said Europe remains a key investment market for China's foreign exchange reserves, soothing earlier concerns over a report the Chinese were reviewing their euro-zone bond holdings.

Benchmark 10-year Treasury notes US10YT=RR were trading 1-2/32 lower in price, with their yield rising to 3.32 percent from 3.20 percent late on Wednesday. The yield, which moves inversely to prices, reached as high as 3.35 percent -- the loftiest level in a week.

"The catalyst was China's emphatic denial that they are considering switching out of the euro," said Andrew Brenner, managing director at Guggenheim Partners in New York.

Worries over contagion from the euro zone debt crisis have been a boon for Treasuries in recent weeks, with benchmark yields falling 69 basis points from an 18-month high of 4.01 percent reached in early April.

With Thursday's price drop, yields were on track for the largest single-day rise in over two months.

"Treasuries have been the beneficiaries of a massive safe-haven bid in recent weeks, and the markets were due for a correction," John Canavan, analyst at Stone & McCarthy Research Associates in Princeton, New Jersey, said of Thursday's price fall.

Thirty-year bonds US30YT=RR fell 2 points in price to yield 4.21 percent from 4.10 percent late Wednesday.

While strength in equities dictated the lower prices in Treasuries, traders were also pushing to cheapen bonds ahead of the auction of $31 billion of seven-year debt on Thursday afternoon.

Seven-year notes US7YT=RR were trading 29/32 lower in price to yield 2.80 percent, up from 2.66 percent late on Wednesday, and some analysts said the jump in yields could boost demand for the seven-year notes in Thursday's sale.

"On the whole, the sell-off should be a plus on the margins," Canavan said.

Treasuries briefly pared losses early on Thursday after the U.S. government's estimate of first-quarter economic growth came in below expectations. Gross domestic product expanded at a 3.0 percent annual rate in the first quarter, below the 3.2 percent pace initially estimated by the U.S. Commerce Department last month. For details see [ID:nN27259780].

"It's disappointing because everyone had expected an upward revision. That didn't come to fruition. This tells you that people were not as happy last quarter as we had thought," said Craig Thomas, senior economist at PNC Financial Services in Pittsburgh.

Two-year Treasury notes US2YT=RR were trading 4/32 lower in price to yield 0.88 percent, up from 0.82 percent late on Wednesday. (Additional reporting by Richard Leong; Editing by Andrea Ricci)

From Reuters