The news media has been full of stories lately how the bull market in bonds is coming to an end.  Interest rates have been at record lows for the last couple of years, and there is really only one way for them to go...and that would be higher.  Since the price of bonds move in the opposite direction of interest rates, we would expect to see bonds lose value.  The media has run story after story about the "experts" who are bearish on bonds...and there are a lot of them.

Bill Gross, the manager of the world's biggest bond fund, recently announced that he cut his holdings of US Treasuries to zero.  Jim O'Neill, Chairman of Goldman Sachs Asset Management, says that US Government bonds may post losses like they did in 1994 if "vigorous" economic growth causes the Fed to change their policy.  Mr. O'Neill says that there are several circumstances that could lead to the kind of battering bonds took 17 years ago, the most important one being a "very dramatic recovery in economic growth." 

If you read beyond the sensationalist headlines, you'll learn that US Treasuries lost 3.3 percent in 1994.  While any loss of value is never pleasant, especially for the so-called "safe" portion of your portfolio, I have a hard time describing a loss of 3.3% as a "savage bear market."

I also found it interesting that, while researching this article, the bond bears were predicting the same thing this time last year...and the year before that...and the year before that.  They all cite the record low interest rates, the economic recovery, and more recently, the massive purchases of bonds by the Federal Reserve. 

Now don't get me wrong, I'm not disagreeing with their logic.  When rates move higher, and a big buyer stops buying, we'll probably see their predictions come true...to some degree.  My point is that if you would have adjusted your portfolio based upon their predictions, you would have missed a couple of more years of steady returns from the bond market.  It is just another good example of why you can't let the headlines drive your investment decisions. 

So, what to do?  We recommend diversifying your bond portfolio just like your stock or fund holdings.  For our clients, we split the bond holdings into short and intermediate-term maturities.  We do not hold any long-term bonds because the academic evidence suggests that while, over time, you are compensated with some extra return for the additional risk of a longer term bond, it is not commensurate with the extra risk you take on.

We also diversify across government bonds, both foreign and domestic, and high-quality corporate bonds.  We also hold a percentage of the bond mix in Treasury Inflation Protected Securities (TIPS).  We do not hold any junk bonds because of the extra risk that they bring.  If bonds are truly the anchor of a portfolio, we want to keep them as safe as possible.  While we can't make them bulletproof, and sometimes they will decline in value, we try to limit the damage as much as we can. 

Finally, it's important to remember that the so-called experts are basing their predictions upon the best information available to them at the time.  But when an event occurs that is truly a "black swan," meaning a completely unpredictable event with important ramifications, their assumptions often go out the window.  I would venture to say that we've experienced two black swans recently. 

The first would be the recent uprising in the Arab world.  While some may say it was predictable, the magnitude certainly wasn't.  And the earthquake/tsunami in Japan, and its aftermath certainly couldn't have been predicted.  When dramatic events like this occur, investors typically seek the safety of what they know best.  And that often means US Treasuries.  So, those bond bears may find themselves playing the waiting game once again.