INVESTING Has surge in bonds run its course?

Bond funds on average were down 1 percent in July.
NEW YORK (AP) -- As bond prices extend their declines, investors are more skittish about bond mutual funds and are clearly worried that bonds' long rally has run its course.
Investors pulled $666 million out of taxable bond funds in the week ending July 23, the largest weekly outflow so far this year, according to AMG Data Services. That outflow was mostly because of funds that invest in mortgage-backed securities and investment-grade corporate bond funds.
Meanwhile, inflows into stock mutual funds totaled $3.2 billion, AMG said.
There's been talk on Wall Street of the bond bubble that has burst, similar to that of the late 1990s bubble in tech and Internet stocks. But Micah Green, president of the Bond Market Association, says the two situations can't be compared.
"When I think of the Internet bubble, particularly the Internet stocks I had ... when the bubble burst, I had nothing left. The value was in the inflated stock price, and when they burst, there was nothing there," Green said. "Bonds are very different."
How bonds work
Green was talking about how bonds work. Bonds are considered safer than stocks, because they are essentially IOUs issued by a government or a corporation. Investors buy bonds on the premise that they will recover their investments along with some interest by the specified maturity date.
"If you bought bonds over the last few years, the value has gone up, up, up, until a few weeks ago. ... Does that mean there is nothing left? No," Green said. "A bond is a loan that pays interest. ... Regardless of what happens to interest rates, that doesn't change."
It's not surprising that bond experts urge investors to stick with their bonds. However, investment experts in general also would agree, recommending that investors have a diverse portfolio including stocks and bonds. Although stocks are the best bet for increasing the cash in your portfolio, bonds are used to preserve it.
"There's always a place for bonds," said Sharon Stark, chief fixed income strategist at Legg Mason. "At some point you want some assurance that you [will] get some money back, at least what you put in."
Positive returns
As far as returns on bond mutual funds go, it's not clear that the bond-buying binge should be over. Although bond funds on average are down 1.3 percent so far in July, they still have a positive year-to-date return of 1 percent, according to fund tracker Lipper Inc.
And bond funds have provided decent returns over the long term. On average, bond funds have a cumulative three-year return of 7.1 percent and a cumulative five-year return of 5.8 percent, according to Lipper.
One big reason why bond prices have declined and outflows from bond funds increased has to do with the economy and investors' expectations that it's rebounding. Earlier this month, Federal Reserve Chairman Alan Greenspan said in congressional testimony the economy is poised for strong growth in the second half of the year, raising questions about whether interest rates are headed higher to follow suit.
Greenspan's bias toward lower interest rates -- 13 times since early 2001 -- to stimulate the economy was a boon to bonds and helped the bond market outperform the bear stock market.
Another reason why bond prices have fallen has to do with a more natural pullback by investors, who bid up bonds earlier this year amid fears about the war in Iraq and the strength of the economic recovery.