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The case for GNMA's for fixed income

Bonds, GNMA vs. DJI for 52 weeksClick to enlarge
Recap of the 2 major downturns:

In the past 52 week period, we went through 2 major fear periods causing stock market corrections: 1st was in November 2008 when Dow Jones Industrial Index (Private:DJI) went to 8000 range and the second one even more severe in early March 2009, when the DJI went into the 6000 range! As I wrote earlier, everything sold off including bonds.

Correlating fixed income vs. stocks:

I have plotted DJI as a proxy for the stock market vs a number of ETF's or mutual funds as proxies of the fixed income intruments: VFIIX (Vanguard GNMA), BSV (Short Term Bond), BLV (Long Term Bond), BIV (Intermediate Bonds), BND (Total Bonds), TIP (Inflation Protected Bonds), PEMDX (PIMCO Emerging Market Bonds) and PHIYX (PIMCO High Yield Bond, aka US Junk Bonds). I wanted to see the correlation of the fixed income market versus the stock market in the 2 fear periods and the subsequent bull market since March lows.

Observations and the case for GNMA's:

1. The highest correlation was of the Emerging Market Bonds and the US Junk Bonds. This shows the Emerging markets are not as decoupled to the US as people make out to be. Also not surprising is that the corporate junk bonds fell in value. As confidence in a company drops, its stock drops and so does its bonds.

2. All the other Bonds (with GNMA's showing lowest correlation), fell during the October-November 2008 fear period. The stock market kept dropping every day. Once stocks sold off sharply in November, people started running towards safety, buying back US treasury bonds in December perhaps creating a bubble in the treasury bonds.
3. The second fear period of March 2009 showed bonds selling off, but not quite as much as fall 2008. This may be due to the fact that the Fed had started buying treasury bonds. In other words the US government was printing dollars to keep the bond market steady. It succeeded.

4. GNMA's did not sell off. In fact they are up 5% in price over the last 52 week period. The Vanguard GNMA VFIIX is also yielding a healthy 4.61%. This is the biggest revelation. GNMA's do not fluctuate to interest rate changes nearly like other bonds. They depend upon the mortgage rates of the underlying paper. Consequently they provide a steadier return than bonds. More importantly there is no default risk, as the underlying paper is guaranteed by the government.

Disclosure: hold position in GNMA and other fixed income instruments mentioned