06/17/96 FEELING JITTERY? THERE WILL BE PEACE IN THE BOND MARKET

FEELING JITTERY? THERE WILL BE PEACE IN THE BOND MARKET
For some investors, it may be the right time to shift money into income-producing instruments
If you like action, the bond market was the place to be last year. This year rising rates and bond volatility have taken investors by surprise. As most economists see it, the outlook for the near future is calmer: steady or slower economic growth and inflation and stable or slightly lower short- and long-term interest rates. Yield spreads of most fixed-income instruments over U.S. Treasuries have narrowed sharply since earlier this year. But for nimble investors, there are still a few good opportunities to maximize yield as well as avoid losses of principal.
The consensus forecast, of course, could be upset. Some analysts see signs of a tighter job market in certain regions and in certain segments of the economy, as well as pressures for higher wage settlements that they believe could lead to creeping wage inflation. And others think bond markets could become jittery if President Clinton is reelected with a Democratic majority in the House.
Still, for investors who worry that the stock market has become too frothy, this may be a good time to shift some money into income-producing instruments. Says Theresa A. Havell, fixed-income manager at Neuberger & Berman, a money-management firm: ``The pendulum has swung too far. There's too much equity risk and not enough fixed income.'' A year ago, she would have advised a hypothetical 45-to-55-year-old investor with $100,000 to put about $60,000 in stocks and the rest in bonds. Today, she says, the stock market ``scares me. I'd be 50-50.'' Daniel J. Fuss, executive vice-president at Loomis, Sayles & Co., goes even further: ``I'd be nearly all in bonds.''
NO FLAT TAX. For risk-averse investors, particularly those below the top tax brackets, Treasuries are a solid bet. Martin J. Mauro, Merrill Lynch & Co.'s fixed-income strategist, who is among those expecting slightly lower long-term and stable short-term rates, advises investors to spread out most of their funds allocated to Treasuries in roughly equal amounts from 2 to 10 years. The yield curve flattens at the long end: Investors pick up less than a quarter of a percentage point by going out to 30 years. But contrarian Robert L. Rodriguez, who manages the top-performing FPA New Income Fund, frets that strong economic growth and waning Japanese interest in U.S. Treasuries will push long rates as high as 7.5% by yearend. For now, he likes Treasuries maturing in two to five years--or longer, if rates do rise.
Municipals remain a good value for income-seeking investors in all tax brackets, especially the highest ones. But they're clearly not as appealing as they were earlier in the year, when the possibility of a flat tax--coupled with the elimination of the mortgage and municipal-bond interest deduction--was still being taken seriously. Since then, the ratio of 30-year, AAA-rated munis to 30-year Treasury yields has retreated from roughly 91% to about 83%. Still, says Merrill's Mauro, ``I liked them at the beginning of the year and still like them.'' He points out that the inventory of munis has been declining for the past couple of years and will continue to do so. California issues may be an especially good buy right now, says Thomas C. Spalding Jr., vice-president at Nuveen Advisory Corp., a New York municipal-bond-fund adviser. Why? The California economy is rebounding, and the 1994 Orange County derivative debacle has proved to be an isolated incident for municipalities.
GO NORTH? Canadian government bonds may be one of the few safe capital-gains plays left on the planet, experts say. Canadian yields are higher in real terms than U.S. rates, says Allen Sinai, chief economist at Lehman Brothers Inc., and they're poised to drop further. Sinai's not as bullish on other parts of the industrialized world, including Japan and Europe, where he expects rates to move higher. But some global bond strategists suggest taking a look at shorter maturity New Zealand and Australian paper, now yielding upwards of 9%. Still, there's some currency risk, and investors will likely have to pay a currency-conversion fee.
Some bond-market bears, such as Bankers Trust Co. Managing Director John K. Burgess, who thinks the Federal Reserve Board will move short-term rates a tad higher this August, find mortgage-backed securities more attractive than most fixed-income investments. He would buy high-coupon Federal National Mortgage Assn. bonds in maturities of from 10 to 20 years. Unless rates plunge, prepayment risk won't be a major threat.
All things considered, many strategists think junk is about the best value around. Although ``neutral'' on the bond market generally, Leslie J. Nanberg, fixed-income chief at Massachusetts Financial Services, finds high-yield corporates ``extremely attractive.'' The spread between the Duff & Phelps High Yield Index and 10-year Treasuries has shrunk to about 3.5% from more than 4% in January, but that has occurred because of improved credit quality. ``U.S. companies generally are not highly leveraged,'' says Nanberg. The experts strongly advise retail investors to put their money in funds rather than single issues.
Top-quality real estate investment trusts (REITs) shouldn't be overlooked either, says Eric I. Hemel, REIT analyst at Merrill Lynch. The average dividend yield for the group is 7.5%, with a total return of roughly 12%, he says. Compared with equity returns, that now looks pretty paltry, but it could appear very attractive if the stock market corrects. ``Arguably, REITs are riskier than bonds,'' Hemel says. But he adds that ``risk-reward analysis favors REITs over most fixed instruments. And REITs give me inflation protection, while bonds don't.'' Because most REIT dividend income is taxable, Hemel recommends REITs for tax-exempt retirement accounts. Currently, he favors Sunbelt apartment-house REITs.
CRAPSHOOT. Emerging-market debt is surely among the riskiest and most volatile investments around. But thanks to faster growth, coupled with declining inflation in many developing countries, the J.P. Morgan Emerging Markets Bond Index has surged nearly 10% since Jan. 2. Nanberg of MFS likes emerging-market bond funds, though he says ``it's hard to argue it's a cheap sector.''
Buying individual emerging-market issues is still a crapshoot for all but the savviest. Bucket shops, warns Neuberger & Berman's Havell, are now promoting so-called Brady Bonds, first issued in 1990 to rescue banks from their Latin loans, as government-guaranteed, risk-free instruments with double-digit yields. She reminds investors that Bradys are below investment grade and that even for those that are collateralized by Treasuries, only the principal--not the coupon--is covered. ``They're very volatile,'' she says.
That, in fact, remains perhaps the only volatile segment of the bond market these days. Bond investors may have very few avenues to reap profits. But they'll probably be able to sleep soundly for a change.
By Phillip L. Zweig in New York