When will it end?

Right now, lack of liquidity is the big problem, Fuss said, so buyers must return for prices to recover. But most buyers feel pessimistic. “People like me say, ‘Wow, look at those spreads,’ … but some investors don’t focus on spreads,” Fuss explained. “They look at [mutual fund] NAVs.” Many mutual fund investors are selling as the net asset value of their funds fall. When these investors start buying again, they could be “the biggest swing factor of all,” he said.

Fuss already sees some buying of corporate bonds. Quiet yet persistent demand for long, high-quality, high-yielding corporate bonds with below-average reinvestment risk sounds to him like defined-benefit pension funds immunizing their fixed liabilities. There’s also low but growing demand from institutions postponing capital expenditures. That might come, for example from a school that broke ground for a new dormitory, but then decided not to proceed right away.

Fuss is also seeing some appetite for asset-backed securities. Traditional distressed buyers “are buying to get their money working” or they’ll have to give money back to their investors. In addition, some investment management firms are buying asset-backed securities.

As for the exact timing of the bond market’s recovery, “I don’t have the foggiest idea,” Fuss said. He likes a quote by Sir John Templeton:  “You buy at the point of maximum pain,” but the big problem, he acknowledged, is identifying when that occurs. 

Whenever that turning point happens, however, corporate bond prices may move quickly. Some investors might miss out if they take the wrong approach to tax-loss selling. The run-up in Treasuries has put bond funds in the unusual position of having capital gains, forcing them to sell to avoid tax losses. Given a choice between selling and later buying back at year-end or going from Fund A to a basically identical Fund B, Fuss prefers the latter because investors who get out of bonds for even a short period could miss out. “I say it is dangerous to take a 31-day gap,” said Fuss, referring to the wait required to avoid losing the loss deduction under the Internal Revenue Service’s wash sale rules. “This market could—not will, and not even probably—pop.”

There could be a fast, short-lived rally in the corporate bond market. “It is so thin that if somebody out there who is immunizing $3 billion of a defined-benefit plan decides that time is running out,” they will buy quickly, resulting in a price increase, with a resulting decline in yields. But then that yield decline will drive them out of the market again.

Fuss sidestepped a question about “where should high-net-worth clients invest for income?” Hang in there,” he said. “It is a terrible time to sell.”

Susan Weiner, CFA, is a writer specializing in investment and wealth management. Contact her through http://InvestmentWriting.com.

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