First-half scorecard: Bonds trounce stocks

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Diversification was an investor’s friend in the first half of 2010 -- just the way it should be.

It turned out to be a lousy six months for most stock markets, after the first quarter’s rally caved in the spring to doubts about the global economy.

But most sectors of the bond market posted gains for the half. As economic worries rose many investors sought the relative safety of high-quality bonds, including U.S. Treasury, municipal and corporate issues.

Long-term Treasury bonds were standouts, as the rush of money into the securities in the second quarter drove market interest rates sharply lower. The annualized market yield on 30-year T-bonds fell from 4.64% on Dec. 31 to 3.91% as of Wednesday, a 14-month low.

As market yields fall the principal value of older, higher-yielding bonds rises. That’s the concept of “total return” in a bond fund: interest earnings plus or minus principal change.

The chart shows the first-half total returns of 16 exchange-traded funds (ETFs) and conventional mutual funds. The list includes popular bond, stock and commodity portfolios. Their ticker symbols are included after their names.

At the top of the list: the iShares Barclays 20+year Treasury bond fund, an ETF that invests in long-term Treasuries. The fund scored a total return of 15.2% in the half. A full 13.2 percentage points of that return was price appreciation, as the shares jumped to $101.75 from $89.89 at the beginning of the year.

Investors love to chase what’s hot, but note: The only way bonds can repeat their first-half gains in the second half is if market interest rates continue to fall. If you’re betting on a double-dip recession, that could happen. But if market rates were to reverse, bond principal values would take a hit.

No. 2 on the winner’s list: the SPDR Gold Trust ETF, which invests in gold bullion. The fund surged 13.4% in the half as the metal rallied amid spooked investors’ search for havens.

Gold reached a record high of $1,257.20 an ounce on June 18 before pulling back in the last two weeks. It ended the quarter at $1,245.50. Many professional investors despise gold as a relic, but it has continued to work as a form of insurance against market, economic and currency calamity. As I’ve noted before, gold will always have some value – which is more than we can say for General Motors’ old shares.

The first-half losers on this list all are stock funds. Funds that invest overseas suffered the biggest declines, mainly because of painful losses in European markets as the continent’s government-debt crisis worsened and as the euro currency fell against the dollar.

Among U.S. funds, those that invest in small- and mid-size companies’ shares held up far better than those that own blue-chip issues. The total return on the iShares S&P SmallCap 600 fund, which tracks the small-stock index of that name, slipped 0.6% in the half.

By contrast, the SPDR S&P 500 Trust was down 6.6%. Steep declines in Big Oil stocks since the Gulf of Mexico catastrophe have weighed on blue-chip indexes.

At the end of last year, many market pros figured investors would want to move up the quality scale to big-name stocks in 2010. Instead, smaller stocks have continued to outperform.

Why? One school of thought is that earnings of big-name U.S. multinational companies will take a hit from Europe’s economic mess, while smaller firms that are mostly focused on the domestic economy might have an easier time showing profit growth.

We’ll find out soon enough whether that reasoning was valid: Second-quarter earnings reports will start to roll out the week of July 12.

In any case, be careful about chasing performance in smaller stocks. If the U.S. economy weakens significantly, survival concerns will become a much bigger issue for smaller firms than the giants.
-- Tom Petruno