Rules of the Game: Bonds in Focus

 | Jun 19, 2013 | 11:00 AM EDT  | Comments
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Stock quotes in this article:

VWO

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dgs

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HYG

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LQD

Beyond news from the Fed and the economic report du jour, investors with a long time horizon–and a financial plan that goes beyond "trade this stock today" – should keep their eye on the continued resilience of the U.S. economy.

Sure, there has been a pullback lately, which sends the growth-only crowd scurrying headlong into cash. But since I'm no longer an adherent of panic trading, I see the market as being in good shape right now. Many in the pundit class – both professional and amateur – have been expecting a sizeable correction, of 10% or so.

At Portfolio, our view is that the major indices are about done with the current pullback, and are likely to trade sideways for some time before rebounding. A larger pullback makes the buying opportunities seem easier, but a sideways market is often vexing and more difficult for traders.

Of course, that works in favor of the longer-term investors who don't get spooked by market gyrations that don't lead anywhere.

More reason to stay calm: Looking at recent data points such as employment, retail sales, ISM, nothing has changed substantially. In other words, the economic data don't warrant making any drastic changes in your portfolio.  Don't listen to the daily dose of media encouragement to "play" this sector or that piece of news.

At this juncture, we have a value bias in global markets. I noted earlier this week that emerging markets are off significantly vs. the U.S. benchmark. Investors looking to take money off the table following the run-up in domestic equities may want to re-deploy that capital into emerging markets.

Emerging markets ETFs that we use include the Vanguard FTSE Emerging Market ETF (VWO) and the WisdomTree Emerging Market Small Cap ETF (DGS). Both appear to have bottomed out for the moment. But even if there is further downside before emerging markets settle down, the point remains: With long-term potential for this asset class still strong, it's not a bad idea to watch for opportunities to scoop up shares at a bargain.

This week's attention to the Fed puts bonds in focus. Plenty of investors want to dump all their bond funds out of fear that fixed-income will fall into the deepest of abysses and never, ever emerge.

Rather than panic, it's better to think tactically about fixed income.  In many cases, it may make sense to shift away from lower-quality bonds. We are slashing our position in the iShares High Yield Corporate Bond ETF (HYG), but we still like the potential for the iShares Investment Grade Corporate Bond ETF (LQD), which contains high-quality corporate-grade bonds.

Is there reason to be concerned about the Fed and what may happen with interest rates in the not-so-distant future? Yes. Does that mean it's time to hit the sell button on every fixed-income vehicle in your portfolio? Absolutely not.

Remember that bonds can be used to lend a dampening effect on your equity holdings.  They are there to balance out the equities, so it's not the best approach to pit one asset class against the other.

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