Although the equity markets have performed strongly over the past years, bonds have dominated most investors’ strategies. With the global economic recovery still anemic, continuing doubts over European sovereign debt and unrest spreading across the Middle East, investors have been willing to accept paltry payouts on government bonds. Those investors who rely most on the income provided by bonds have taken on higher levels of risk by purchasing low-rated debt with high yields.

That trend has reversed over the past months as capital has flowed out of fixed-income funds and into equity-focused fare. Increasingly, that money has gone to foreign stock funds. According to data released by Lipper, US domestic equity funds experienced net outflows of $3.9 billion last week while foreign equity funds saw inflows of $1.4 billion.

To a large extent, the impact of the US Federal Reserve’s policy on inflation has helped drive that shift in investor sentiment.

The Fed has pumped vast amounts of stimulus spending into the financial system and kept interest rates artificially low for three years in the hopes of jumpstarting the economy. Numerous studies have attempted to prove that the stimulus has saved US jobs. But most investors have focused on the inflationary pressures caused by the Fed’s policies.

Data from the Federal Reserve–which most analysts believe understate domestic inflation–shows that inflation in the US remains manageable. But many blame cheap and abundant US dollars for high levels of inflation in emerging markets. As a result, global governments have stepped up interest rates even as the Fed steadfastly asserts that low rates are required to keep the US recovery on track.

Many investors have questioned how long the Fed can keep interest rates this low; food and energy prices are rising in the US and global governments are losing patience with America’s low rate policy. As a result, investors have sought to reduce their exposure to fixed-income and the US market, renewing interest in international markets and vehicles that will allow them to bet against bonds.

Exchange-traded fund (ETF) issuers have stepped up to meet that demand, as demonstrated by the products that hit the market last week.

What’s New

A new line of six leveraged and unleveraged foreign bond exchange-traded products came to market under the PowerShares brand, including:

• PowerShares DB Japanese Government Bond Futures ETN (NYSE: JGBL)
• PowerShares DB 3X Japanese Government Bond Futures ETN (NYSE: JGBT)
• PowerShares DB 3X German Bund ETN (NYSE: BUNT)
• PowerShares DB German Bund Futures ETN (NYSE: BUNL)
• PowerShares DB 3X Italian Treasury Bond Futures ETN (NYSE: ITLT)
• PowerShares DB Italian Treasury Bond Futures ETN (NYSE: ITLY)

By using the exchange-traded note (ETN) structure, the PowerShares offerings overcome the difficulties of setting up country-specific debt funds, making these the first exchange-traded products to provide pure exposure to a single country’s debt. The lineup currently offers three times leveraged and no leverage to futures contracts on government bonds issued by Japan, Germany and Italy with 10-year maturities. I wouldn’t be surprised if PowerShares expanded its offerings.

The timing for the release is fortuitous. Japan has seen demand for its bonds soar; investors anticipate the country’s central bank will inject huge amounts of liquidity into the financial system to contend with the recent earthquake and nuclear crisis. Investors will also be keen to play German and Italian bonds in light of Europe’s continuing sovereign debt worries. It’s not happenstance that these new ETNs cover the strongest and weakest European economies.

I strongly suggest investors avoid these ETNs until they build up volume; the average daily volume on these products has yet to break the hundreds of shares. Although it would be easy to purchase these shares, selling would likely be difficult.

Direxion Shares expanded their fixed-income offerings with the launch of Direxion Daily Total Bond Market Bear 1X Shares (NYSE: SAGG), Direxion Daily 7-10 Year Treasury Bear 1X Shares (NYSE: TYNS) and Direxion Daily 20+ Year Treasury Bear Shares (NYSE: TYBS).

Direxion is best known for offering highly leveraged funds, but all three of these ETFs offer straight inverse daily exposure to an aggregate bond index and intermediate- and long-term Treasury indexes.

These three funds should fare well. Investor sentiment toward bonds will grow increasingly bearish amid expectations of an interest rate hike and higher inflation rates. All three funds carry an expense ratio of 0.65 percent. This should prove alluring to those with a bearish outlook. But investors should recognize that these funds reset daily. Consequently, their performance may differ dramatically from the indexes they track.  

ProShares Short High Yield (NYSE: SJB) offers inverse daily exposure to the iBoxx $ Liquid High Yield Index. Although I generally don’t recommend funds of this ilk–particularly funds that reset daily–ProShares Short High Yield is appealing.

Junk bonds have soared over the past years as investors have had to hunt further for yield. Junk bond funds have seen their assets surge and the spreads between junk bonds and higher-rated fare have narrowed considerably. I wouldn’t characterize the huge run up in junk bonds as a bubble. But I believe we’ll see valuations plunge once the Fed raises rates. This could be an excellent fund for tactical traders, though it’s not appropriate for investors with a buy-and-hold strategy.

Finally, IQ Global Agribusiness Small Cap ETF (NYSE: CROP) launched last week. Agriculture has emerged as an extremely popular investment theme. The logic for investing in agriculture is simple: As production capacity strains to keep pace with population growth, prices will likely continue to rise. The recent unrest in the Middle East, said to be caused in large part by food price inflation, seems to support this long-term trend.

This spells more opportunity in the agriculture space and small-cap companies will likely benefit the most. Investors have piled into the best large-cap names, leaving small-cap valuations at relatively modest levels. Small-caps also will likely enjoy the greatest growth in local markets, making them increasingly attractive takeover targets.