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Today's World of Bonds - What You Want Versus What You Can Get


Take what the market gives you. Take risk when others won't...

While going over yesterday's conversation between Minyan Ed and Toddo in the piece entitled 'Psychic Income', I could not help but think of the pressures facing all of us today to produce a respectable yield in portfolios while assuming a reasonable and appropriate amount of risk. Let's be realistic. Yields around the world in most traditional investments aren't exactly high. The funny part is that our Treasury yields are the highest amongst the G-7 nations. But once you strip out inflation (not core inflation but real inflation-the kind that includes the food and energy we all use daily), you are not left with much of a return, if anything at all.

Todd's background lies in the world of equities, the wonderful Professor Succo's in options and derivatives and mine in the boring land of bonds. We all try (even though I am new to the Ville) to share our expertise that we have garnered over the years with subscribers with the hope that we can add some value to your investment portfolios. Having traded bonds, sold bonds and managed bond portfolios over the past 25 years or so, I have come to learn that bonds aren't as boring as you might like to think. And with that, I would like to take this time to reminisce about some of my experiences and how it relates to folks like Minyan Ed. It may help some of you to better understand bonds and the world that we live in.

In the first place, bonds can be boring-sometimes. You buy a bond, clip the coupon, wait for it to mature and start all over again. When I first started in the industry, way back in 1981, you could buy a 30 year AAA rated municipal bond at 13% or a 15% Treasury bond, clip your coupon, retire in your rocking chair, smile and clip those big, fat coupons. Granted, inflation was high, but that would not last forever. Today, many people I come across 'need' a return of 6 to 8% on their nest egg to retire. For some, it is because they spent their time and money raising and educating a family and for others, they simply consumed too much and saved too little during their careers. This is where the point of what you want versus what you can get comes into play.

One thing I have learned in my career (we all get smacked by the proverbial 2 x 4 occasionally and learn our lessons) is do not stretch for yield. Take what the market will give you and move on. This applies in equities, preferred stocks, mutual funds and individual bond issues. When something looks too good to be true in the markets, I have usually found, later on after a loss, that there was a reason it was so cheap. My point here is to stay with quality, particularly for a retiree. After all, the older you are, the more difficult it is to replace lost capital.

We live in a world where debt controls the entire economy, as many of us write here on the Ville. Asset values must continue to rise at increasing rates or money supply must grow faster to keep up with the debt service. In my eyes, this will lead to an eventual credit crunch, where corporate bond yields will perform extremely poorly as people lose faith in the mountains of debt that exist. The last credit crunch took place in 2002 which came as a result of loss of confidence in our major corporations after the collapse of Enron, Adelphi, etc. Junk bond spreads were routinely 1000 basis points (10%) above Treasury yields. Today they are at the lowest level in years, around 325-350 basis points. But the credit crunch that sticks with me the most was the one that was real-estate related back in 1990. Remember the RTC bailing out all the failing banks due to poor real estate loans. A couple of memories stick out in my mind from that year. I was an institutional bond salesman for Smith Barney at the time. A client called and said that they 'needed' to sell $5,000,000 A rated Unisys 9% bonds maturing in 1996 (these bonds had a par call in 1993). I called the investment grade trading desk for a bid and was referred to the junk bond desk because they refused to bid the bonds. The trader on the junk desk yelled out a bid of 25. The sad part was that we didn't know if the bid was $25 per $100 or 25% yield to maturity. The same day I had some AA rate Chase Manhattan bonds to trade. I was told that the market was 50-60, period. In other words, there was a 20% spread between bid and offer. I am sure others that have lived through these types of times have a little more gray hair than others. It is just part of the job.

My point in all of this? Take what the market gives you. Take risk when others won't-by the way the Unisys bonds were called at 100 in 1993! When the market beckons you to try to grab a little extra yield, don't try to. If something looks too good to be true, stay away. When fear mounts, take risk, no matter if it is stocks, bonds, or real estate. Capital preservation is the key in times of high risk. I have learned these things the hard way and hope that it will help others from repeating the same mistakes I have seen others make over the past 25 years, including me.
No positions in any securities mentioned

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