In 2007, high-quality bonds are expected to outperform junk bonds. An economic slowdown is anticipated, because of falling home prices and rising mortgage payments. In a slowdown, junk bond defaults may increase and values could drop. Considering current low yields, investors are not being paid enough to take the risks of owning junk bonds.
High-quality bonds include Treasuries and mortgage-backed securities. Money managers generally prefer short maturities, in the range of two to five years. If the economy slows and the Federal Reserve lowers interest rates next year to perk things up, bonds maturing in two to five years should be good performers.
Longer-term bonds are not as appealing. There recently has been a rally in long-term bonds so those prices have moved up. What’s more, long-term bonds are the ones usually owned by foreigners so they may lose value if the dollar weakens and foreigners reduce their holdings of U.S. bonds.