To those who are simply glomming on to a higher bond weighting because of their outperformance over the past decade, I have one word for you: Don't.

Beware of so-called safe investments: Safety may not be all that safe (all investments have risks). Curiously, some of the most overheated areas are securities backed by the full faith and credit of the U.S. government: Treasury bonds, GNMA mortgages, and five-year Treasury Inflation-Protected Securities.”

“In the high-yield credit markets, it is time to party like it's 2006.  Companies left for dead a year ago are now finding that investors are clamoring for their high-yield debt. Private equity-backed businesses are paying their owners dividends out of new bond issues. In all, companies raised $11.7 billion last week in the high-yield bond market, the biggest in history, according to Thomson Reuters.

High-yield bond deals may be setting themselves for a big fall, when high interest payments come due.

It looks like risk is on the backburner again as investors are reaching for yield. And issuers are all too happy to oblige in meeting the insatiable demand.

For most issuers, the new debt isn't going toward building new factories or funding acquisitions. Instead, these new deals are repaying existing debt and pushing back maturities. These overleveraged companies hope they can get more time to improve operations and benefit from an economic recovery.

Some Wall Street deal makers say the current high-yield bonanza only delays the day of reckoning. But companies are happy to use the proceeds to pay off less expensive senior bank loans. The bonds lack the restrictive covenants of loans, which often require minimum liquidity levels, restrictions on spending and other operational metrics borrowers must maintain.

With the Federal Reserve keeping interest rates near zero, yields on government debt have stayed low, forcing investors searching for decent returns to chase riskier paper like junk bonds.

They're all yield junkies. Did everyone forget that 2008 happened? Talk about a short-term memory loss on the part of the buyer."

Stock market bulls see the sudden rush for the relative safety of bonds as a "contrarian" signal.  Investors "always are conditioned most by whatever we just lived through," said Bob Doll, vice chairman at money management giant BlackRock Inc. In this case, he said, people understandably are fearful that the market could crumble anew, even though the economy has begun to grow again and the financial system has at least stabilized. (LA Times 12/31/09)

Most bonds (other than Treasuries) had good gains in 2009. But there may now be an overvaluation bubble in many bond categories, especially Treasuries.  In early 2009 most bonds were priced based on the high risk of default, as investors feared a Depression

Treasury prices fell on the last day of 2009, pushing the 10-year Treasury to its largest annual loss in value in 30 years. (Marketwatch 12/31/09) In mid January 2010, Treasuries had a rebound based on very strong demand even with less foreign buying but high demand by U.S. investors. Treasury values are expected to fall again but the timing is unclear.

12/31/09 (MarketWatch) -- Treasury bonds will fall next year, lifting yields as the economy slowly improves, giving investors one more reason to stay away from a sector which had its biggest annual loss in three decades in 2009, according to U.S. bond dealers.

A gradual return to more normalized Fed policies and gradual rate increases to more historic norms should not have a major impact on the economic expansion - the economy has done well in the past with Fed normalizing policies.

Australia's Central Bank was the first to raise interest rates in 2009 and their equity markets did very well afterwards.

After large gains in 2009, Morningstar says 1/6/10 "As the markets have recovered, municipal bonds have moved toward a more normal relationship with Treasuries...However, many non-traditional municipal buyers have disappeared and often only retail investors are providing liquidity to the market."

The interest rate risk as rates move up is mathematically greater with muni bonds than Treasuries since their yields are lower with their tax-exempt status.

1) Recovery strategy to help maximize potential market rebound over the next few years.

2) "Participate yet Protect" strategy especially for longer term funds to protect from future market crises.

3) Pure Protection strategies such as various cash options or annuities, but not U.S. bonds due to high interest rate risk, and many are warning that bonds may be in a valuation bubble that could burst.

The three strategies can be combined within a portfolio, depending on your objectives.

For our recovery strategy, we do not recommend just index¹ returns but funds that have historically consistently outperformed the “dumb” indexes or ETFs with positive Alpha (outperformance vs. risk taken).

Past performance does not guarantee future results.