Don’t Fall off the Bond Market Cliff (ABB, BND, CSJ)

The rush to the cliff in long-maturity bonds of all types is accelerating. That’s bad news for us buyers. A Wall Street Journal article described recent corporate bond offerings as almost entirely focused on the long end of the maturity curve – greater than 10 years. That’s the exact opposite of where buying should be in this market.

There are two major forces at work that are fueling this blind eye to the obvious risk in long-maturity bonds and what will be one of the worst collapses in market history. One is reasonable, the other is just pathetic…

Businesses are rushing to get bonds to market to lock in the incredibly low rates the market now offers, and to lock them in for as long as possible.

That’s why all the new corporate offerings are at 10 years or longer. It makes perfect sense from a cost perspective.

With rates as low as they are, all businesses should be trying to sell as many bonds as possible before the turnaround in rates. Perfectly reasonable!

Don’t Be a Rate Pig!

The other force at work is what I call “Rate Pigitis” – Pathetic!

Investors – I use that word loosely to describe this group – are jumping on anything that has a better yield than money markets or savings. “Jumping” may not be the right word… “impaling themselves” may be a better description for what’s going on…

Anyone buying any kind of bond on the long end of the maturity curve is setting himself up for a horrific beating when these rates move higher – and they have to move up.

This beating won’t be because there’s anything wrong with the bonds the uninformed are buying. Corporations are in better financial shape now than in many years. So, the bonds are actually quite good from a credit perspective.

The problem is the same one it’s always been: When rates move up, prices drop and the uninformed sell like crazy. This selling causes an acceleration in the price drop and the panic is in full swing.

The Real Problem…

The bonds aren’t the problem; it’s the people who own them and what they do with them.

Buyers on the long end of the maturity curve are looking at one thing and one thing only: yield. The longer the maturity of a bond, the higher the yield. Yield is all they’re interested in and that’s where the big trouble starts.

Traditional, ultra-conservative investors, CD, money market, bond buyers, are snapping up anything with yield and ignoring the consequences. It’s just another form of panic.

The other side of this panic buying is as ugly as the market can offer. Market prices for these long maturity bonds can drop 50% in a heartbeat once the panic selling starts, and don’t kid yourself, it will be a panic and it will wipe out millions of investors. Unfortunately, it will wipe out those who can least afford it: the retired.

Of course, the typical argument the buyers of long maturities make is that they must have income from their investments to live – and long maturities are the only place to get it… Wrong!

There’s plenty of income in the three-to-seven-year maturity range and a lot more protection from the ravages of the unavoidable sell-off to come. In fact, in the right bonds, you can make more income and capital gains at maturity in many cases and significantly limit your downside when rates move up. Significant means about 10% or less.

Most buyers in this market haven’t taken into consideration how strong the urge is to sell when your monthly statement shows a big drop in value. But you’re still being paid your interest and principal at maturity, so it seems logical to ride it out – though, you and I both know that isn’t what happens.

The good news in all of this gloom and doom is that thriving in this bond market, despite historic low rates and the urge to follow the lemmings to the cliff (again) is quite easy. It requires the same boring, old, time-proven techniques that have always worked.

  • Buy bonds in out-of-favor companies with solid fundamentals.
  • Don’t fix what isn’t broken.
  • Don’t chase overpriced investments.
  • Own ultra-short maturities, only!

Long-maturity bonds have had a good run for the past few years, but the party is almost over. You don’t want to own them when interest rates turn around. Take your profits now and shift gears to shorter maturities – or forever hold your peace…

Good Investing!

by Steve McDonald, Investment U Research


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