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Investors rush into bond market, but will the big payouts last?

Posted: Friday, October 11, 2002

NEW YORK (AP) -- If you play the stock market these days, there's a good chance that anything you put in, you won't get back out.

And that may soon be the case with bonds, too.

Investors have rushed into U.S. Treasuries, thinking they're guaranteed moneymakers during these turbulent times on Wall Street.

For much of the last two years, that's been true, but don't count on that to last. There might be nowhere to hide your money anymore from plunging investment returns.

The government bond market is starting to look like the Nasdaq right before it burst: Overvalued.

It's been a bumpy few months for investors. The stock market, which had been sinking for the last two years, took a steep dive this summer and remains volatile now. The threat of war with Iraq is also unnerving investors.

That has spurred a rush of money out of stocks and into bonds. What a change from just a few years back, when investors' eyes would glaze over at the mere mention of bonds.

About $32 billion poured into mutual funds buying U.S. Treasury securities in the third quarter, more than twice the previous high tallied by AMG Data Services since it began collecting mutual fund data in 1992.

For all of 2001, about $28 billion was invested in government bond funds. In 1997, $8.9 billion was taken out.

The total return on government notes and bonds during the third quarter was 7.23 percent, according to Merrill Lynch.

That's still not huge by bull market standards, but it sure looks a lot better than the double-digit declines seen by most stock market indexes over the same period of time. The Standard & Poor's 500 index and the Dow Jones industrial average were both down more than 17 percent from July through September.

The increasing demand has given a real jolt to bond prices, as has the steep decline in interest rates. The Federal Reserve lowered rates 11 times last year in an attempt to jump-start the economy.

Surging prices have sent Treasury note yields, which move in the opposite direction of the price, to more than 40-year lows.

But can this bond-market rally last? While a war with Iraq might extend the good times for a bit, the majority of market-watchers believes a downturn is inevitable.

''Where are interest rates going? I don't think that they have anywhere to go but up,'' said John Bilardello, managing director at Standard & Poor's.

That means bond prices could tumble as the Fed starts raising rates again to ward off threats of inflation once the economy begins to pick up steam.

For investors, that's bad news.

Bond-fund investors will likely see their returns start to shrink because there won't be the huge price appreciation that was seen over the last few years.

''Bond funds have produced excellent returns, but you can't project those same returns into the future,'' said John Hollyer, a principal and senior portfolio manager in the fixed-income group at The Vanguard Group.

The situation may be even worse for anyone who has recently bought individual government bonds or intends to do so at these lofty prices, and then needs to sell before they mature.

Over the last few years, that's how bond investors have made big money. Since the market has been rising, they bought low and sold out at higher prices.

But chances are, since it's nearing the top of the market now, you won't get your money back if you have to sell down the road.

Say you buy a $1,000 10-year bond now with a 5 percent interest rate. A year from now you go to sell it, and at that time the interest rate on a new bond that you could buy on the open market for the same duration and price is 7 percent.

Your bond then looks overpriced to potential buyers because the interest payout is less, so you'll have to lower the price to close the sale.

Investors who hold on to their government bonds until they mature will get the payout promised when they bought them. It's those who need to sell early who might very well get caught short.

Government bonds have been the bright light during these tough times on Wall Street. They've actually made money, while stocks have seemed so hopeless.

But now they're looking like a bubble ready to burst.

------

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org



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