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Category Archives: Bonds

Boomer Retirement: Headwinds for U.S. Equity Markets?

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Over the past few weeks I’ve read reports from the S.F. Federal Reserve, Credit Suisse, H.S. Dent and Jim Fink that have been echoing a similar story.   The story has to do with the coming Baby Boomer demographic shift and its impact on the stock, bond and real estate markets.  The outlook is not good, especially for equities.  I’m linking below to the report put forth by the S.F. Fed and a link to where you can download the Credit Suisse report.

If you do not have time to read the entire report, I’d highly recommend you at least skim over the report.  The visuals are helpful in summarizing and communicating the main observations.

In next month’s edition of TheMarketCapitalist.com newsletter I will be discussing how you may need to adjust your investment strategy in light of the information contained in these and other reports.

http://www.frbsf.org/publications/economics/letter/2011/el2011-26.html

http://www.scribd.com/doc/81556120/7754802-Cs-How-Demographics-Affect-14-Feb-1

Barron’s Mid-Year Roundtable

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If you missed it this weekend, I’m linking to Barron’s mid-year roundtable article from this past weekend’s edition.  I feel that this year’s group discussion at mid-year is particularly helpful, since we’re currently down from where we started at in the beginning of the year.  Therefore, this could potentially be a window of opportunity for your portfolio to finish the year strong.  A little guidance from a few market experts might help, too.

For those unfamiliar, the Barron’s roundtable is an annual event, which brings a number of notable investors together to discuss what they see in the year ahead and what stocks, funds, commodities and other investments they are bullish or bearish on.  The mid-year meeting provides greater insights into what has changed or remained the same from their forecasts from January.

I find this annual roundtable group very helpful for the individual investor.  For one, it helps investors get a sense of what the ‘pros’ are thinking about and what they are attracted to.  Secondly, it’s a point at which you can start branching off in your research.  By this I mean that you may come across ideas that lead you to consider other related investments.

Ten market pros offer their investment advice for the back half of 2011.

2011 Mid-Year Roundtable Report Card.

Take Note: PIMCO bets against U.S. government debt

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The world’s largest bond fund began betting against the United States last month by taking short positions on its debt on expectations the nation’s shaky finances will drive interest rates higher and imperil its triple-A rating…READ MORE.

My Take: PIMCO is the ‘largest bond fund’ referenced above.  As you may know, Bill Gross the Chief Investment Officer of PIMCO has expressed his concerns over excessive government debt in the U.S. for a while now.  If the article is correct, Gross is now putting his money where his mouth is (in figurative terms).

I think Gross is of the opinion that big cuts to defense, medicare, medicaid and social security are very unpopular with the majority of Americans.  Big cuts throughout these programs are not likely to be something that a politician can help get re-elected.  If this is true, then the drive to make sufficient cuts in the budget are likely to be to weak willed to control the tide of government debt.

As government debts increase more Treasuries will need to be purchased.  More debt will make the U.S. look more risky to investors, which will require a larger interest rates to be offered to attract buyers.

We live in very interesting and challenging times.

The Trouble With Low Rates

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Low rates have created quite a dilemma for those with cash stakes who are suddenly at a loss for how to make a reasonable return on their money. This is becoming an even bigger problem as inflation begins to heat up. With cash earning 0%, it won’t take long until investors lose lots of purchasing power…READ MORE.

My Take: While I understand the rational for low rates in these difficult economic times, I worry about the unattended consequences. Saying we’ll do X in order to cause Y to happen is pretty straight forward, but what is changing because we’re doing X and causing Y to occur? As Milton Friedman once stated, “There’s no free lunch.”

Low interest rates are great for many people/businesses, but they are also a burden for others. If you’re a retired person attempting to structure your portfolio to meet a certain fixed income level, the job now is more difficult than ever. With rock-bottom rates being given to savings, money-market and CD accounts, you almost have no choice but to increase your portfolio’s risk to obtain the return you need to get by.

Younger people might not think about the difficulties of these rates on those retired because they’re not dealing with an equivalent situation. The problem of receiving little reward for putting your money away in FDIC secured accounts is a real one. It’s going to become even more real, if we see a growing amount of inflation throughout the economy. Not only will savers not be rewarded through higher savings rate, but they will be penalized by an increasing rate of inflation.

If savers turn to the market to get their interest rate/dividend yield fix, what happens if the market stumbles? Maybe it won’t happen, but if it does, it’s not going to be pretty for a lot of people that are indirectly being forced into investments that carry varying degrees of risk.

As more of the baby-boomers become retirees, a greater need will be placed on investments that can provide for a monthly or quarterly income payment. If interest rates are kept down by the Fed, retirees will continue to be forced to take more risk than what they had planned to take in order to earn a level of return necessary to maintain their standard of living. Artificially low rates do not provide a free lunch.

Basic Bond Pricing

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Bond Pricing

Par Value – Initial offering price of the bond (typically $1,000 for corporate, $5,000 for municipal and $10,000 for federal)

Coupon Rate – This is the interest rate you expect to receive annually over the life of the bond.  Typically made in semi-annual payments (2 times a year).

Maturity Date – The date when the bond will come due.  You no longer are receiving any coupon payments and your initial investment is paid back in full.

Primary Market – This references when the bond is first sold by its institution.  The bond sells at par value.

Secondary Market – After the bond has been taken by an investor the investor can sell the bond to other investors.  The bond may or may not sell at par value to other investors.

Premium or Discount – If a bond sells for less than par value, then it’s selling at a discount (less than $1,000 for a corporate bond).  If a bond sells for greater than par value, the it’s selling at a premium (greater than $1,000 for a corporate bond).

What causes bonds to sell at a premium or discount? – When the going interest rate changes (coupon rate) for bonds with certain maturity dates, this will cause the bond to sell for a premium or a discount.

  • Rule – If the going rate is now higher than what your coupon rate is, then your bond will sell at a discount.  If the going rate is now lower than what your coupon rate is, then your bond will sell at a premium.
  • Do a search for a bond price calculator or formula if you need the exact number.

What are Bonds? & Bond Credit Ratings

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Bonds

  • Bonds are debt notes issued to the public/investors.
    • As a bond holder you receive a premium (coupon rate – think interest rate) for lending your money to a company or government.
    • At the end of the bond’s life you expect to receive your principle (initial investment back).
  • Companies and governments that issue bonds receive a credit rating.
    • Based on the credit rating, the company/government will have to pay a higher or lower premium to attract investors.
      • The higher the rating a company/government has, the lower the rate that must be offered.
      • Ratings go from AAA to D.
      • Bonds with lower ratings have a higher chance of defaulting (not paying you what you were stated)
  • The length of the bond’s life also impacts the coupon rate (premium) that must be offered to attract investors.
    • Rule of thumb – the longer the maturity date the greater the premium offered compared to bonds with lesser maturity dates.