Like a Hollywood vamp, the stock market hogs all of the headlines when it reaches new highs, giving short shrift to the bond market's own remarkable rally - a 1% fall in the 30-year Treasury bond yield in 30 days.
That stunning reversal worries many bond managers, however, who now are shifting to a defensive stance.
By June 2, the yield on the benchmark 30-year Treasury bond fell to an intraday 15-month low of 6.34%. (On June 7, the yield had risen to 6.54%, based on remarks by Federal Reserve Board Chairman Alan Greenspan that he was not concerned with the economy's weakness.)
"We call it a 'Led Zepplin' formation - a stairway to heaven," said Geoffrey Kurinsky, portfolio manager at Massachusetts Financial Services, Boston. The last leg of the bond rally began April 30, when the long bond yield broke 7.20%.
"Boy, it was fast and furious," he said, adding May was the best month in the bond market since 1985.
And therein lies the problem.
"It's a very dangerous market," said Laird Landmann, fixed-income manager at Hotchkis and Wiley, Los Angeles, which runs $700 million in bonds.
"We're at a dangerous point. As interest rates come down durations extend, so bonds are becoming more risky and price sensitive. The probability of being right has decreased, and the consequences of being wrong have increased," said Hugh R. Lamle, executive vice president of M.D. Sass Investors Services Inc., which runs $1.5 billion in fixed income.
The force of the bond market rally took portfolio managers by surprise.
At a December 1994 economic outlook briefing, managers at MFS predicted long bond rates would come down below 7% during the second half of 1995. But at a midyear outlook in May, rates already were at 6.74%.
Les Nanberg, senior vice president and chief fixed-income officer, said MFS now is de-emphasizing the U.S. bond market in global portfolios. It is focusing on Australia, Canada, Europe and Japan.
If the Republican flat tax proposal is passed, the housing market could be hurt because mortgage interest no longer would be tax-deductible, and a flat tax would mean "the end of the municipal bond market as we know it," Mr. Landmann said.
"We're staying pretty close to home base," by keeping the average duration of "total return" bond portfolios in line with the benchmark Lehman Brothers Aggregate Bond Index, about 4.4 years, Mr. Landmann said.
Besides the outcome of the Republican flat tax proposal, another wild card is whether sectors sensitive to interest rates - such as housing and auto sales - rebound from the drop in interest rates. Such a rebound might spook the bond market by fueling inflation fears.
What's more, a number of managers said the market's current level anticipates an easing of 50 basis points by the Federal Reserve this summer, which may or may not occur.
"You're at an inflection point. Technically, we're due for a consolidation phase, with the market going sideways if not pulling back," said Jeff Koch, a portfolio manager at Strong Capital Management, Menomonee Falls, Wis. "The market doesn't continue trading in one direction forever. The next big move will be the result of what happens with fundamentals." Strong Capital runs $4 billion in fixed income.
Hotchkis and Wiley's Mr. Landmann believes the recent weak economic figures are not signs of a slowdown, just a pause. He thinks any easing by the Federal Reserve in July will be slight and that the Fed will tighten monetary policy later this year or next, amid consumer spending increases and employment growth.
Mr. Lamle also thinks the economy probably will strengthen in the fourth quarter.
"Our view had been that as the economy decelerated, we'd see interest rates temporarily decline. It's close to having run its course," said Mr. Lamle.
"We're much closer to a bottom in rates than a top. .*.*. I'd be very surprised to see (the 30-year Treasury) break 6%, whereas I wouldn't be surprised to see it well over 7% by the end of the year.
"In the next several years, interest rates will be on a volatile but increasing trend because of increased demand for funds by developing nations of the Third World" such as China, India, Pakistan, Korea, Taiwan and Latin American countries, as well as the United States, Japan and Europe.
"We are maintaining intermediate-term durations and not looking to extend durations."
Mr. Lamle also said the weak dollar could lead to higher inflation as domestic manufacturers raise their prices in response to higher prices on imported goods.
David Schroeder, senior portfolio manager of The Benham Group, Mountain View, Calif., which runs $10 billion in fixed income, is cautious but not bearish.
"It's a market that looks rich, but the fundamentals and technicals have supported it," he said, citing such factors as positive cash flows into bond mutual funds in March, and signs of a slower economy since the fourth quarter of 1994. What's more, currency market interventions by foreign central banks to support the dollar have boosted the U.S. Treasury market.
"Typically when the market rallies, short yields decline more than long, but long yields are down at levels not seen since early 1994," Mr. Schroeder said.
Consequently, his portfolios at Benham are structured to do better in a market where interest rates rise and short yields rise faster than long yields. "I'm a little conservative at this point. .*.*. Even though fundamentals and technicals are positive, the market's probably run as far as it can run near term."
"The Treasury market is priced for a decline in the federal funds rate of 50 to 100 basis points from here (6%)," Mr. Schroeder said.
"If the Fed doesn't lower rates as much as expected or the economy picks up steam, there might be a setback in the broader market," Mr. Schroeder said.
Lord, Abbett & Co., which runs $10 billion in fixed income, also is playing it safe. "We've eliminated principal-only securities and moved our duration to 80% of the benchmark (Lehman Aggregate)," or about four years, said Robert Dow, partner.
"In February we were looking to see the economy slow down to 1.5% to 2.5% GDP growth," which suggested a trading range of 7% to 8% for the long bond, Mr. Dow said. Now, with the long bond at 6.5% and the 10-year Treasury at 6%, "unless we're going into a recession you can't sustain these levels."
But Strong's Mr. Koch is taking a more aggressive stance.
"We are long, and happy to see this market trade up, yet we're wary. We would expect a consolidation phase. .*.*. We're going to be vigilant to try to adjust portfolios accordingly."
Since the 75 basis-point tightening by the Fed last November, Strong's portfolios have had durations longer than their respective benchmarks. Durations were further extended in May to 115% of their benchmarks.