Bonds Funds Seen As Hedge Against Stock Market Dip

Bond mutual funds, which have been out of favor with investors, may be poised for a modest comeback in 1997.

The reasons: low inflation in the United States, moderate global economic growth, interest-rate steadiness (with the Federal Reserve now standing pat), and the prospect that rates may fall if the economy cools later in 1997, as many economists expect.

Moreover, since stock mutual funds look increasingly vulnerable to many investors, bonds have taken on a new glow.

Overseas, central banks have been heavy buyers of US Treasury issues in recent months, attracted by the combination of low inflation and stable yields. Assuming overseas economies do not pick up sharply, more foreign money may roll into the US Treasury market this year, analysts say.

The bottom line: Bonds should outperform stocks for much of 1997, says Eric Miller, chief investment strategist for financial house Donaldson, Lufkin & Jenrette. The firm's current model portfolio, for a balanced stock/bond account, is 45 percent fixed-income securities, 45 percent stocks, and 10 percent cash.

"The bond market is a definite niche for investors who want less volatility than found in the stock market," says Michael Fields, chief investment officer for fixed instruments at AMR Investments, in Ft. Worth, Texas. Mr. Fields, who manages $5.9 billion, forecasts some volatility in fixed-income markets in the first half of the year, prompted by concern that the Fed might raise interest rates to slow the economy. But growth should slow enough in the second half of the year - in part because of slower consumer spending - that the Fed may ease rates a tad, he speculates.

For much of 1996, individual investors were reluctant to commit money to bond mutual funds. (In November, bond funds recorded net inflows of $1.3 billion, compared with net outflows of $430 million in October.)

James Benham, vice chairman of American Century Investments, says interest rates on 10-year Treasury bonds could be in the 4 to 5 percent range by 2000. They are currently around 6.5 percent. For investors, such a dip could provide significant capital gains on current bonds that have higher yields. On a 10-year Treasury note, the yield and capital gains together might add up to about 10 percent annually. By comparison, many analysts predict modest gains of 10 percent or less for stocks.

When interest rates are falling, as mutual-fund analyst Reg Green points out, the longer the duration of a bond, the larger, in most cases, is the capital gain.

Sheldon Jacobs, who publishes the No-Load Fund Investor, a market newsletter, sees selected bond products as hedging against a possible stock-market dip - as long as the bond market doesn't go haywire, too. Among these are:

*Short-term fixed-income funds. Average portfolio maturities run two to five years. They have a slightly higher yield than money-market accounts, but some share-price volatility.

*Bonds and bond funds. These, he says, tend to be "modest" bear market hedges. It used to be that stock and bond markets traveled divergent roads, with bond products not declining as frequently as stocks in bear markets. That is often no longer the case. Bond prices dropped in seven of the 17 quarters since 1982 that the Standard & Poor's 500 stock index declined.

*International bond funds. They have done well in three of the last four downturns.

*High-yield "junk" bond funds. Jacobs sees them as substitutes for equities, not havens. They pay out high interest, but can be very risky. Still, many high-yield funds did especially well in '96 and are expected to remain competitive this year.

Another risky fixed-income winner of '96 was emerging-market debt - up about 40 percent.