Bonds Above Par by Most Since '10 Stoke Tenders: Credit Markets

Richard Bravo, ©2012 Bloomberg News
Thursday, March 1, 2012
Article from San Francisco Chronicle

March 1 (Bloomberg) -- Investment-grade bonds in the U.S. are trading above par by the most in almost 16 months, raising the odds that companies will try to boost earnings by refinancing high-coupon debt held by investors.

The average price on bonds from aluminum producer Alcoa Inc. to Bentonville, Arkansas-based Wal-Mart Stores Inc. have soared to 111.55 cents on the dollar, Bank of America Merrill Lynch index data show. Wyndham Worldwide Corp. sold $800 million of notes with coupons as low as 2.95 percent to buy back debt trading as high as 122.5 cents and paying as much as 9.875 percent.

Pressure is mounting to boost profits with the Standard & Poor's 500 Index valuation averaging 13.7 times earnings this year, the lowest annual level since 1989, according to data compiled by Bloomberg. Borrowing costs have fallen to record lows for the most creditworthy borrowers as concern wanes that the European sovereign-debt crisis will imperil the global economy.

"Investment-grade bond issuance is primarily being driven by the refinancing of outstanding debt," John Lonski, chief economist at Moody's Capital Markets Group in New York, said in a telephone interview. "All this is bringing attention to how low current fixed-rate borrowing costs are relative to historical trends."

Repay Debt

About 92 percent of bonds in the investment-grade index trade above par, with 18 percent above 120 cents, Bank of America Merrill Lynch analysts wrote in a Feb. 28 report. Virginia Electric & Power Co.'s $700 million of 8.875 percent senior unsecured bonds due 2038 were quoted at 165.2 cents on the dollar Feb. 28, the highest premium to par.

Lower financing costs have enticed borrowers to sell $384 billion of bonds this month, up from $344 billion in January and the most since $430 billion in May, Bloomberg data show. This year, 81 percent of proceeds from dollar-denominated bond sales have gone to repay debt, according to Lonski.

Elsewhere in credit markets, default insurance on Greek debt won't be paid out, the International Swaps & Derivatives Association said after it was asked to rule whether part of the nation's $170 billion bailout was a credit event.

The group said the European Central Bank's exchange of Greek bonds for new securities exempt from losses being imposed on private investors hasn't triggered $3.25 billion of outstanding credit-default swaps. ISDA's determinations committee, including JPMorgan Chase & Co. and Pacific Investment Management Co., said the switch didn't constitute subordination, one of the criteria for a payout under a restructuring event.

'Still Evolving'

"The situation in the Hellenic Republic is still evolving" and today's decisions "do not affect the right or ability to submit further questions," ISDA said in a statement. The decision is not an expression of the committee's "view as to whether a credit event could occur at a later date," the association said.

A benchmark gauge of U.S. company credit risk declined, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing by 1.6 basis points to a mid-price of 92.3 basis points at 11:05 a.m. in New York, according to Markit Group Ltd.

That's the lowest level on an intraday basis since July 22 for the index, which typically falls as investor confidence improves and rises as it deteriorates.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 1.4 to 127.4.

The market for corporate borrowing through U.S. commercial paper declined to the lowest level in more than a year as investors shunned short-term IOUs from financial institutions on investor concern that Europe's fiscal strains will taint bank balance sheets globally.

Wyndham Bonds

The seasonally adjusted amount of commercial paper outstanding fell $10.4 billion to $927.2 billion in the week ended yesterday, the third consecutive decrease, the Federal Reserve said today on its website. That's the longest stretch of declines since the period ended Jan. 4 and the lowest level since the market touched $916.8 billion on Jan. 19, 2011, according to Fed data compiled by Bloomberg.

Wyndham Worldwide, the franchiser of Days Inn hotels and Super 8 motels, sold $300 million of 2.95 percent senior unsecured notes due March 2017 and $500 million of 4.25 percent senior unsecured notes that mature March 2022, the Parsippany, New Jersey-based company said in a Feb. 27 statement.

Proceeds will be used to buy back at least portions of its $250 million of 9.875 percent notes due 2014, its $800 million of 6 percent debt maturing in 2016 and its $250 million of 7.375 percent bonds due 2020, the company said.

'Good Spot'

All three of the bonds that Wyndham is seeking to tender are trading above par, with the 9.875 percent notes falling 0.47 cents Feb. 28 to 118 cents on the dollar, Trace data show. It has traded above par since July 2009, the data show.

"The markets are in a good spot, Treasuries are doing reasonably well and spreads have tightened significantly overall," Tom Edwards, treasurer at Wyndham, said in a telephone interview. "It's both taking advantage of the market situation and being proactive in managing our maturity profile."

Investment-grade bonds have returned 3.09 percent this year, following a gain of 7.5 percent in 2011, Bank of America Merrill Lynch index data show. The par-weighted price, the highest since November 2010, is up from as low as 87.6 cents in March 2009.

The extra yield investors demand to hold investment-grade bonds in the U.S. rather than similar-maturity Treasuries declined to 206 basis points as of Feb. 28, the lowest since August, according to the Bank of America Merrill Lynch U.S. Corporate Master index. Yields on the debt declined to 3.42 percent, the least in the bank's data going back to October 1986.

Fed's Pledge

The Fed pledged in January to maintain its benchmark lending rate, which has held at zero to 0.25 percent since 2008, at "exceptionally low" levels through at least late 2014.

As rates have held at record lows, companies have reduced the amount of interest they owe, providing a one-time boost to earnings and improved cash flow, Lonski said.

Net interest payments for non-financial companies fell to $104.5 billion in the third quarter of 2011, from as high as $262.4 billion in the fourth quarter of 2007, according to the most recent Moody's data.

Buffett Bonds

Warren Buffett's Berkshire Hathaway Inc. issued $1.7 billion of bonds on Jan. 24 to refinance debt sold to help pay for its acquisition of Burlington Northern Santa Fe. The Omaha, Nebraska-based company said proceeds may be used to repay bonds that came due in February, according to a Jan. 24 filing.

Investors' appetite for debt from the most creditworthy corporate borrowers has increased with the European Central Bank awarding 529.5 billion euros ($706 billion) in a second round of three-year loans to banks to help ease cash shortages at financial institutions.

The rise in issuance is largely being driven by the Fed's efforts to keep long-term Treasury yields low, said Moody's Lonski.

"One of the purposes for the Fed policy is to facilitate the refinancing of outstanding debt at lower interest rates," said Lonski. "And apparently the Fed is having some success doing so."

--With assistance from Patricia Kuo in London and Mary Childs, Sapna Maheshwari, Sarah Mulholland and John Parry in New York. Editors: Alan Goldstein, Faris Khan

To contact the reporter on this story: Richard Bravo in New York at rbravo5@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

Article from San Francisco Chronicle

How to Invest During a Bond Bubble

By Amanda B. Kish, CFA | More Articles 

February 23, 2012

Article from The Motley Fool

Last year was largely marked by uncertainty and fear -- and also by significant inflows out of the stock market and into bonds. Skittish investors stuffed billions of dollars into fixed income mutual funds and ETFs in an attempt to escape the ongoing volatility. And while every investor, even those decades from retirement, can benefit from at least a minimal exposure to bonds, it's getting harder and harder to argue that fixed income isn't at the tail end of a spectacular bull run.

Interest rates are still hovering at historical lows, which means rates have nowhere to go but up, and bond prices have nowhere to go but down. And with signs that the economic recovery is finally gaining steam, interest rate hikes could come a lot sooner than anyone expects.

That means there's a lot of risk in the fixed-income sector these days. But for investors who want to protect their capital and dampen volatility within their portfolio, bonds are still the best option. Here are a few tips for investing in bonds in today's challenging market environment.

Cash-ing in

While bonds should be a primary feature in any retiree's portfolio, there's one adjustment you should make if you are retired or will be in the next few years -- keep a stash of cash to pay for near-term living expenses. Bonds tend to experience much less volatility than stocks, but they can still get hit with short-term losses from time to time.

So I believe that any money that you will need to access in the next five years should be kept in cash. A good money market account is a safe bet here. You won't be earning much, if anything at all, on this portion of your portfolio, but it will be immune from market movements, which is more important for your near-term needs.

On the short side

Duration is a measure of a bond or bond fund's sensitivity to a change in interest rates. Bonds with longer durations will be more strongly affected by changes in interest rates. So if you own a bond fund with a duration of five years, that means for every 1% that interest rates go up, your fund will fall in value by 5%. Short-term bonds and bond funds have much lower durations and are therefore more immune to changes in interest rates.

For example, the Vanguard Short-Term Bond ETF (NYSE: BSV  ) has a duration of just 2.7 years, which means it will fall about 2.7% for every percentage point that interest rates rise. On the other hand, the Vanguard Long-Term Bond ETF (NYSE: BLV  ) clocks in with a duration of 14.4 years. Clearly, the long-term-focused fund would be hit pretty hard by even a small rise in rates.

Now, if you're thinking that one obvious way to minimize interest rate risk is to plow all your assets into short-term bond funds, you're right -- but you probably don't want to do that. Because yields are so paltry, especially on the short end, loading up on short-term bonds means that you are effectively strangling the yield right out of your portfolio. That's the whole reason longer-term bonds offer higher yields -- to compensate you for the risk of tying your money up for longer periods of time. And since there's no telling exactly when rates will rise, you could miss out on a lot of money by sitting on the short end of the yield curve if rates continue to stay low.

So while you might want to shorten up your duration a bit by adding a short-term bond fund into the mix, you should also keep some exposure to higher-yielding intermediate-term bonds. For example, the Vanguard Total Bond Market ETF (NYSE: BND  ) has a duration of 5.0 years, while the Schwab U.S. Aggregate Bond ETF (NYSE: SCHZ  ) measures in with a 4.3-year duration. Either of these funds would make a good complement to a shorter-duration fund like the aforementioned Vanguard fund or the Schwab Short-Term U.S. Treasury ETF (NYSE: SCHO  ) with its 1.9-year duration.

Of course, if you don't want to dirty your hands with the whole concept of duration in the first place, you might want to consider investing in a first-rate actively managed bond fund like Dodge & Cox Income (DODIX). Here, an experienced team of fixed income investors will actively adjust duration as needed based on changing market conditions so you don't have to worry about it.

In it for the long haul

One last thing to remember is that even though bond investors are especially risk-averse and place a high value on avoiding losses, sticking to a long-term buy-and-hold bond strategy means that any near-term losses will eventually be more than offset by higher yields. While bond prices will fall in response to rising rates, investors or fund managers can now buy bonds with higher yields. In the span of just a few short years, that added yield will more than make up for the loss in price your bonds will experience. So by keeping your focus on the longer-run picture, you'll eventually end up ahead of the game -- but not if you try to cut your losses and hide out in cash in the meantime.

There's no telling when rates will finally start to head back up, but they will. If you're a bond investor, you shouldn't panic or dump your holdings in an attempt to time the market. Rather, with a few quick adjustments to your portfolio and a proper long-term mind set, you can safely ride out what promises to be a challenging few years for the fixed-income asset class.

Even though investors have rediscovered their love for bonds in recent years, odds are they won't provide the same level of returns going forward -- and that could put your retirement at risk. Our newest special free report highlights the shocking truth about your retirement. Don't miss this chance to grab your free copy of this can't miss report today!

Article from The Motley Fool

The Ultimate Guide to Bond Investing

by Steve McDonald, Investment U Research
Monday, February 20, 2012
Article from Investment U

Corporate and municipal bond investing has one major problem: When interest rates go up, bonds go down.

Actually, bond investing has two major problems. The second is that people are rate pigs. They always go for the highest payout on bonds and bond funds and ignore the problems associated with long maturities.

The result is that when bonds do drop in value, which they will do at some point, the drop is accelerated by “rate pigitis” – really accelerated. Long maturities drop in value a lot more than short ones.

So, a bond investor has to make a choice:

Go with really long maturities, get higher yields and suffer through the sell-off when rates go back up…

Or:

Go for shorter maturities and put up with lower returns, but a much smaller drop in value when the sell-off finally happens…

Of course, there are those who think, “I’ll just wait it out and collect my interest, ignore the big drop in long maturity bonds and collect my principal at maturity.”

Right! And Obama will suddenly develop a sense of business and economics and stop jerking everyone’s chain.

The Real Truth

Here’s the real truth about the average small-bond investor.

The combination of “rate pigitis” and being completely unable to wait out a sell-off in any market – not the just the bond market – have turned one of the safest investments, bonds, into what will be one of the biggest money losers in the history of the markets. Treasuries included.

In the past few years, rates have settled where I have never seen them in my lifetime. Meanwhile, small investors have been standing in line to pour their money into bonds of all kinds in the hope of escaping the stock market volatility and getting some kind of return on their money. I can understand why… It’s been 10 years since we made a dime on stocks.

All of this money is going into bonds at exactly the wrong time, in all the wrong ways and at prices so high, they have to come down.

It will be a blood bath of biblical proportions when almost everyone cuts and runs as prices drop.

The Staggered Approach to Bond Investing

But this is completely avoidable. There’s a way to own bonds now and get around this impending bloodbath, and still beat the stock market.

In fact, if you use a staggered approach to bonds, rather than the usual ladder, you can:

Get very high rates of returns.

Minimize the drop in value when interest rates rise.

Take advantage of higher rates and the bargains they present in a down bond market.

And still sleep at night, too…

I know, too good to be true, right?

But this isn’t a guarantee of any kind, you will have some losses – very few, but some. Based on today’s market averages about one to three out of a 100 trades will be losers.

Sounds good, doesn’t it?

And, you will have to follow all the rules! Yes, rules of the road that cannot be ignored. Any Navy folks out there know what that implies. Standing Orders and all!

Right off the bat, that eliminates about 25% of all investors, big and small. That bottom 25% is doomed by the fact that they don’t know what to believe and are so inexperienced they can’t separate the good information from the garbage.

Another 25% will only play the “swing for the fence” game in the stock market. They will figure it out eventually, but not until they have lost so much they go back to CDs and money markets. At least they aren’t losing anymore.

Another 25% know they have the secret to success and will only buy stocks, because they know the secret, right?

So that leaves you and me and few other survivors who are able to see a real opportunity.

Here it is! It’s called a “staggered bond portfolio.” Your broker will tell you it can’t work, but I have been proving him wrong for a long time.

Forget Everything You Know

First, forget everything you know about corporate bonds, and munis for that matter, especially how to structure a portfolio of them.

Think in terms of very small bond positions, as few as one bond per position, five or more is preferable, but you can do one. I know brokers will tell you it is impossible to buy less than 10 or 20 bonds. Baloney! Get another broker who knows something about bonds!

The Rules of the Road

Buy many bonds of almost all credit qualities, as low as CCC. Right now, I prefer to stay in the BBB to CCC range, but the skittish can go for the higher ratings if you need them to sleep at night. But the BBB to B ratings don’t have that much more risk and the slightly lower-rated bonds are where all the money is.

Buy bonds in many industries. Don’t load up on a few tech names or familiar names. Stay diversified just as in a stock portfolio.

In the current market, shoot for an average maturity of five years or less. That means you can buy a few really good ones at seven years and a few that don’t look as good in the one- to two-year maturity. Then fill in the blanks.

As the market shifts to higher interest rates, this strategy will shift to longer maturities and the higher rates that come with them. But for now, you must stay very short on time. This market requires it.

Never load up on a single bond because you like the return. This is the biggest trap and the biggest money burner in the business. Just ask the folks who bought Lehman Bros. bonds, AAA at the time, because they had a great interest rate and a really good rating.

For the average person, that’s someone who isn’t managing millions, there’s never a good enough reason to buy more than 10 bonds in any one position.

Plan on buying lots of different bonds so when the bad news does hit (and it will eventually), it only affects about one to four bonds out of a 100, and you don’t have your whole life hung out to dry in one position. I’ll bet you can guess which bonds will get you into trouble. Here’s a hint, it won’t be the small positions in your portfolio.

Look for bonds whose underlying companies just had some bad news; missed earnings, bad product, lawsuit, etc. It will kill the stock and the bond will slip, too, but here’s where the difference between stocks and corporate bonds really shines.

The only question you need to ask yourself about that bond is, “Will the company be in business when this bond matures?” The answer in almost 99% of cases is, “Yes.”

That’s it! Let the stockholders die on the vine as this thing gets pummeled. You buy the bond while it’s down, collect the interest and capital gains, wait for the bond to go back up in value – which they do in most cases – then sell it or wait for maturity and collect your principal and interest.

Two More Advantages

There are two more advantages to this short staggered portfolio. Take a look at the example below of what a portion of a complete staggered portfolio looks like.

Notice you have several bonds coming due each year. This is key to this strategy. This allows you to buy back into the market at higher rates several times a year. This gives you all kinds of flexibility that laddering doesn’t.

In a traditional laddered portfolio, you have to wait several years for a bond to mature to be able to buy another. That can hurt in a fast changing bond market, which is what I’m expecting in the next few years.

Maybe the most beneficial aspect of the staggered strategy is you can see the horizon. You can see that there’s money coming due, and you know you will get your principal back, and that gives you a psychological advantage over all other types of investments.

Being able to see that horizon – I call it the light at the end of the tunnel – makes it that much easier to sit tight and wait out the worst that any market has to offer.

You have to be there at the end of the race to have any chance of being a winner.

That’s how you avoid the bloodbath that’s coming in the bond market, reduce your risk, avoid the volatility of the stock and make real money in bonds.

Good Investing,

Steve McDonald

Article from Investment U