Volatility Reveals the Riskiness of Higher Yielding Sectors

One of the arguments that Chairman Bernanke has used for its quantitative easing program is that the Fed’s buying of Treasuries and Mortgages would force investors into riskier assets to earn a respectable yield.  The Chairman has repeatedly pointed to the increase in the stock market as proof that the Fed’s quantitative easing program is working.  Along with equities, prices of below investment grade bonds, emerging market debt, and closed end bond funds reached record highs in price as shown by their record low yields.  It is no surprise then when Chairman Bernanke, in comments to Congress on May 22nd, hinted that the Fed could reduce the amount of bonds it purchases in the next few meetings investors reacted by selling these securities.  An article in the New York Times on Friday entitled “A bond Market Plunge That Baffles Experts” highlighted the fact that a popular mortgage REIT fund was down 8.7% last month, while many high yield and mortgage focused funds were down more than 10%.  We would council that it is reasonable for the Fed to begin discussing a reduction in its bond buying program since the unemployment rate has fallen from 8.1% last summer to 7.6% last month.  Accordingly, investors should not be surprised to see sectors of the market that have benefited the most from the Fed’s  quantitative easing to be hurt the most.  We will be watching and ready to take advantage of this volatility.