Where to Find the Bargains

UPSIDE Updated March 2, 2012, 6:37 p.m. ET

Article from The Wall Street Journal

Stocks and higher-yielding "junk" bonds have surged so much in recent months that bargains are getting difficult to find.

At the same time, safer investments such as Treasury bonds and high-grade corporate issues have meager yields.

Faced with this dilemma, investors should plan for lower returns ahead. But they also can look to certain pockets of value within the stock market, as well as some junk-bond funds with a history of beating their peers without taking on too much risk.

Investors have turned sweeter on risky assets in part because of a smattering of good economic news. The U.S. economy grew by 3% in the fourth quarter, faster than originally reported, the government said Wednesday. Jobless claims are near a four-year low. The inventory of homes listed for sale has shrunk.

But investors also have been nudged toward risk by the Federal Reserve, which has been buying Treasury bonds to drive down interest rates. On Jan. 25, the Fed gave an unusually long look ahead, saying the Fed funds rate is likely to remain "exceptionally low" at least through 2014.

That means bond yields, which move in the opposite direction of price, aren't likely to soar soon. The 10-year Treasury recently yielded 2%, versus an average of 6.2% since 1953. Yields on high-grade corporate bonds are likewise near record lows. Procter & Gamble last month issued 10-year bonds with a 2.3% coupon. H.J. Heinz this past week sold five-year bonds that pay just 1.5%. Most money-market mutual funds pay less than 0.25%.

Meanwhile, the inflation rate was 2.9% over the year through January. The upshot: investors are looking at paltry, or even negative, returns in safe investments like these, after adjusting for inflation.

The problem is that risky assets have run up sharply. The Standard & Poor's 500-stock index has returned 9.7% this year through Thursday—close to what it has historically returned, on average, in an entire year. The index has roughly doubled from its financial-crisis low three years ago.

One way to tell whether stocks are cheap or expensive is to compare prices with company earnings. The S&P 500 closed Thursday at 15.8 times reported earnings for the past four quarters. Its historical average is 15.5 times earnings, according to data provided by Yale University economist Robert Shiller.

Stocks are worth a premium during periods when earnings are poised to grow quickly, all else held equal. But Wall Street's earnings forecasts have been steadily falling over the past six months, according to Howard Silverblatt, senior index analyst at S&P.

This quarter's earnings are now expected to be just 6% larger than those from the same quarter a year ago, when the growth rate was 16%. (Please see "Playing the Profit Wave," Page B9.)

So while stocks don't seem wildly overpriced, they do seemed priced for mediocre returns.

But there are good deals to be found within some sectors. Among the 10 economic sectors represented in the S&P 500, financials are the least expensive, discounted about 15% to the broad index, based on trailing earnings. And earnings for the group are projected to grow just as fast as those for the index this quarter.

On the other hand, technology is priced on par with the broader market, but its earnings are expected to grow faster—this quarter, by 10%.

Investors can get broad exposure to these sectors with modest expenses via exchange-traded funds like iShares Dow Jones U.S. Financial Sector Index and Technology Select Sector SPDR. But each sector has some parts that are more attractive than others, says Mitch Rubin, a managing partner at RiverPark Advisors, an asset manager overseeing $350 million.

Among financials, Mr. Rubin dislikes companies that are in the primary business of lending money, because yields are so low. That rules out most banks. But he likes Blackstone Group , because as a global investment company it has exposure to rising wealth. The company is structured as a limited partnership and must pay out the bulk of its profit in dividends. It currently yields more than 5%.

In technology, Mr. Rubin shuns old-line computer makers that are struggling to hold on to market share. He favors eBay and Google because both have more cash than debt, are priced in line with the market and are growing their profits by double-digit percentages.

High-yield bond prices have soared, too, as yields have plunged. The Bank of America Merrill Lynch U.S. High Yield Master II index recently yielded just over 7%, down from about 20% during the financial crisis.

Investors should expect total returns of closer to 4% a year on these bonds, according to a recent analysis by MFS Investment Management in Boston. That's because junk bonds tend to lose around two percentage points of their return to defaults on average. Also, the average junk bond is now selling at a premium to what investors will receive at maturity. That, along with trading costs, could shave another percentage point or so from returns.

It is possible to shop for bargains within the junk-bond universe, but that is best left to experienced mutual-fund managers, says Eric Jacobson, head of fixed-income research at Morningstar .

Some funds have a better record than others of delivering solid returns without excessive risk. Mr. Jacobson likes Vanguard High-Yield Corporate and Fidelity High Income , both of which have relatively low fees.

The Vanguard fund costs 0.25% a year and has a yield of 5.5%. It returned 6.2% a year over the past 15 years, versus an average for high-yield funds of 5.3%, according to Morningstar data. The Fidelity fund costs 0.75% a year, yields 5.8% and has also returned 6.2% a year over 15 years.

A final thought for savers looking for a place to park cash: Now might be a relatively good time to spend some of it. Any purchase carries an opportunity cost in the form of the return that could have been earned if the money were invested. That means spending looks more attractive now than it did three years ago.

That isn't a reason to squander, of course. But the new roof and the family trip to the Rockies that got put off during the market crash are starting to look like better deals relative to what is on offer in the stock and bond markets.

—Jack Hough is a columnist at SmartMoney.com. Email: jack.hough@dowjones.com

A version of this article appeared Mar. 3, 2012, on page B7 in some U.S. editions of The Wall Street Journal, with the headline: Where to Find the Bargains.

Article from The Wall Street Journal

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