What Have You Done for Me Lately?

The word is out: bonds have nowhere to go but down.  Is this really true?  Well, basically yes.  Certainly, as to short term rates, the game is up.  You'd have to be crazy to buy treasuries (of any kind), and the great majority of corporate bonds have yields so low that an upward movement in rates will trash their market value.  On the whole, this is one of the least propitious times I've ever seen to invest in bonds.

So, is there NOTHING I can do for your now?  Well, if I had a large lump sum, I would NOT pour it all into bonds.  But if you're investing bodaciously, then this too is a year in which you will buy some bonds (remember, this is your base investment amount adjusted yearly for inflation plus any income you aren't spending).  So, you would want to examine the horizon for a decently rated bond that beats present inflation by a good margin.

How would you look?  My absolute favorite site for researching bonds inexpensively is E*Trade.  They have a bond search function that is first-rate.  Put in the your search parameters (say yields over 6.5%, ratings above junk, and maturities after 2025), and it will spit out bonds matching the parameters.  I did that today, and got 18 results (excluding a number of split grade bonds rated at junk by S&P or Moodys, but investment grade by the other).

One no-brainer jumps out: a Goldman Sachs 6.45% issue 5/1/2036 trading at 97.5 and yielding 6.7%.  Another is a 6.65% Bank of America bond maturing in 2026.  It is priced at par.  Since BOA and Goldman Sachs are among the magic ten U.S. banks receiving TARP funds in 2008/09, they have an implicit government guarantee.  These bond have very little risk.

Other real possibilities relate to the Euro crisis.  Some very big, and pretty sound banks have bonds with big yields:  BBV Intl Finl Ltd 7% 12/01/2025 trades at 90 to yield 8.2%.  This is Spain's second largest bank, with a present Moody's rating of A2 (S&P BBB).  As a large sovereign nation, Spain will do nearly anything to shield this bank (and its mammoth sister Banco Santander) from default. The rest of Europe also has a vital stake in seeing Spain's banks survive.  So, you'd also want to take a look at Abbey National PLC 7.95% 10/26/2029 trading just above par to yield 7.8%.  It's a subsidiary of Banco Santander, but is backed by the company's UK assets.

In light of the fact that interest rates are due to go up sharply after 2014, why would you buy now?  The best reason is that you're following a plan.  You really don't know what's going to happen, you just think you know.  Buying now locks in a predictable flow of money until the bonds mature.  If present yields were near the lows of the 1950's, I might suggest holding off, as the odds would be stacked against you.  But guess what?  With inflation running somewhere around 2.5%, these present yields of 6.6 to 8.2% look fairly juicy. So, I would go ahead with the plan.

By the way, I have talked about the Moody's BAA yield so much that you might think I'm being literal about a 30 year horizon.  Not at all.  If you see something long-term (that could be as little as ten years, but more likely 15, 20, 30, or even 50 years) with favorable characteristics, then grab it.  The maturities will even out over time.

Next, a word about ratings.  One of the coolest things about the E*Trade website is that its bond research includes the Moody's report.  This is a detailed discussion of the company, its outlook, and why Moody's think it deserves a given rating.  Now I know you have heard about how the ratings agencies blundered big time in the mid-2000's.  They assigned AAA ratings to CDOs that ultimately failed massively.  So, why would you listen to them when they talk about bonds?  Well, to be blunt, these guys didn't know squat about CDO's, but bonds are their business.  They've been in that business for a century, and they're pretty good at it.  Because they're writing for an ultra-cautious clientele, they tend to be quite cautious as well.  That means that a given rating allows for quite a variety of things to go wrong.  In addition, Moody's will assign an outlook to the rating: negative, positive, neutral.  So, a BAA bond with a negative outlook contains a warning that certain bad things could happen.  Bottom line, a Moody's rating will be a very good guide to what is likely to happen with a given issue.  That guide will likely be more reliable than your personal research.  There are never any guarantees, but a solid Moody's rating is usually reason enough for me to take action.

One final point.  Each bond listing will show a bid/ask spread.  The first is the price you would get if selling a bond, the latter what you will pay to purchase.  This spread is a serious cost of doing business, as bond spreads are typically far higher than  those for stocks. The trading fee charged by E*Trade is, in comparison, trivial (typically $1 a bond, or $10 for a $10,000 par position).  My point?  Bonds are NOT trading vehicles for folks like us.  Buy and sell a few times, and you'll go broke.  If you keep the bond (ideally to maturity), then that ask premium will decline in importance, particularly if you've bought at a discount to par.  After all, what should interest you primarily is the yield, both now and to maturity.  If it is generous enough, then you needn't worry that somebody else (the pro who's selling, for example) has snagged a better price.