Bonds Expected to Outshine Other Securities in 1994

THE United States bond market - one of the better performers in 1993 in terms of total returns for investors - looks ready to post another good year in 1994, although analysts say it will not be quite as stellar as last year.

Municipal bonds, issued by local and state governments, will probably ``do better than most other investment-grade, fixed-income securities,'' says Richard Ciccarone, director of tax-exempt fixed income research at Kemper Securities Inc., a Chicago investment house. The after-tax yield on municipal bonds is expected to exceed the yield on corporate or US government issues, Mr. Ciccarone says. Some $69 billion in new Treasury notes and bonds will be offered starting this week.

Corporate junk bonds also are expected to provide solid total returns this year. But these taxable issues carry greater risk than municipal bonds, which usually have the full backing of local government agencies.

In terms of total returns - price gains, interest payments, and capital gains - 1993 was a solid year for the bond market in general, Ciccarone says. Total returns on bond mutual funds, for example, including capital gains, often exceeded the return on stock funds.

Lipper Analytical Services Inc., a financial services company in New York, found that 19 of the 78 bond funds it monitored posted total returns exceeding the average total return on equity funds, which was 12.54 percent.

With investor dollars pouring into bonds, mutual fund companies expanded the number of bond funds. In early 1993, according to Lipper, there were some 2,681 fixed-income funds; by the end of the year, there were more than 3,350 fixed-income funds.

``More and more investment groups are coming out with bond funds that have shorter [maturity] terms and more intermediate terms,'' says Erick Kanter, a spokesman for the Investment Company Institute in Washington. Bonds with shorter terms provide greater stability to investors worried about maintaining their principal. Bond prices move in the opposite direction of interest rates: As rates climb on new bonds, the price goes down on outstanding ones, potentially producing a loss of principal on investment.

While attention was focused on equities last year - with the Dow Jones Industrial Average reaching new highs - investors put more monies into bond mutual funds than equity funds. Hundreds of billions of dollars flowed from bank certificates of deposit and, to a lesser extent, money-market funds, into the higher-yield bond funds. In 1993, net sales of bond funds reached $134 billion through November, the best year ever, Mr. Kanter says.

YIELDS on bonds are expected to stay relatively steady in 1994, with inflation running in a low 3 percent range and steady-as-you-go economic growth. At the end of 1993, the yield on 30-year US Treasury bonds was 6.34 percent. At the end of last week, the yield had dipped slightly to around 6.26 percent. At the beginning of 1993, the yield was about 7.30 percent.

Richard Hokenson, chief economist with Donaldson, Lufkin & Jenrette Inc., a New York investment house, says long-term rates could climb slightly - perhaps even to the 6.50 percent range - before declining and then ending in 1994 at around 5.75 percent.

In terms of total assets, taxable money-market mutual funds posted no major change last year, says Dennis Jarrett, chief technical analyst for Kidder, Peabody & Co. Inc. That suggests that in taking advantage of higher interest rates on bonds, investors reduced holdings in bank certificates of deposit faster than in money-market accounts, he says. It also suggests that investors now use money-market accounts as quick sources of liquidity, much like a checking account.

After last week's earthquake in southern California, some bond analysts are concerned about a possible downgrading of municipal bonds issued in the state. California issues more municipal bonds than any other state in the country. Still, federal disaster relief is expected to offset issuing agencies' temporary inability to meet their financial obligations.