This 2nd Week of April 2022 Thoughts: bonds bonds bonds
Updated: Sep 23, 2022
This is Good:
Starbucks CEO Howard Schultz has returned to his former role: the coffee giant’s founder began his stint as interim chief executive by immediately suspending the company’s stock buyback program. “This decision will allow us to invest more into our people and our stores—the only way to create long-term value for all stakeholders,” he said in a letter to employees and shareholders.
It’s a hugely significant moment, not only for Starbucks employees but potentially for workers across the country. Put simply, the company is shifting money from investors to its workers. Shareholders didn’t seem overly perturbed as the stock edged lower in pre-market trading.
This Week’s Fund Profile: One of my tools as we move through this time of rising rates is not just a fund, but my Skye Rising Rates Bond Capsule Portfolio. Over the next 6 months, we’ll buy into this 3-4 times. See the attachment.
Cash is a legitimate asset class: sometimes the safest place is on the beach. Dan Niles
When the federal government spends more than it takes in, they borrow money from us…investors…by selling bonds. Historically, the largest deficits were caused by national emergencies like wars or the Great Depression. It would be one thing if our tax code was designed to fund these times, in addition to the operations of “the largest company of all,” but it’s not. This rapidly growing imbalance between revenues and spending has led to an increasing national debt balance.
The coronavirus crisis accelerated an already unsustainable fiscal trajectory because of its devastating effect on the economy and we all knew the time would come to address our rising debt. At some point the interest-on-the-interest is more than the debt and what used to be out there in the future, is here. Now.
The 2007-2009 financial crisis began years earlier with cheap credit and lax lending standards that fueled a housing bubble. When the bubble burst, the very financial institutions that had made a ton of money processing loans, collapsed, and WE the American people in essence, “bailed” banks out by earning 0% on our safest investments: money markets and bank accounts. The FED poured money into the system, and we all know when there is too much of something, the price has to go down to lure buyers into the market. Low interest rates also encouraged borrowing and investors had to look to the stock market, the only game in town.
It does not help that this banking crisis was global, and that the rest of the world has shared our pain and now has to live through the tough-love from this multi-decade binge-fest. There is good news however, and the light at the end of the tunnel is not a train! The Fed, who is responsible for this mountain chart above, is here at the rescue and generations will talk about this time: the Great Payback. There is an investment playbook that will help us navigate it, and while we will get through it, just know, we must Keep Calm and Carry On.
Bonds don’t usually get much respect but this year, they have made it to the big time. Once you understand how this normally sleepy asset class works, and the potential that smart bond buys could have for your portfolio over the next 1-2 years, you might get as excited as I am right now. This week the Federal Reserve announced they were going to fast-track selling the bonds they have been piling up on their balance sheet over the last 10 years. This shift from “dove to a hawk” sent the Bloomberg Global Index below $100 for the first time since 2009. This index has traded between $102 and $112 since 2009.
So how do bonds work? Bonds are issued at “Par” which is $100 per bond and they mature at $100, but in-between these two key dates (usually 20-30 years) they can trade all over the map. When bonds are over $100 it is called “trading at a premium” and when they are below $100 it is called “trading at a discount.” Recently, investors have been paying a premium for bonds: this means you will lose money if you hold til maturity! But, think about the alternative: if you can buy bonds below $100 you have the potential for capital appreciation.
When a company needs to raise money they can sell shares of their company stock or issue bonds and borrow from investors. Bonds have a covenant that defines the legal obligation the company has to the bond holders; the interest they will pay (often semi-annually); when they will pay back what they borrowed (often 20-30 years) and if there is collateral to protect investors if they default on payments. 😊Why does this matter to you? Your total return is the income paid AND whether you sell the bond for a profit or loss. If you pay $100 per bond, and it matures at $100…your return is just the interest you have earned. Here is where the fun comes in: if you buy the bond for less than $100 and it matures at $100…you have capital gain to add to your dividend. If you pay more than $100, however, and it matures at $100…your return is reduced by that amount and you have a capital loss.
Most of your bond holdings are in bond mutual funds…baskets of bonds that are diversified. Think about the complexity! Every bond fund has hundreds of bonds, all changing price every day. When a bond in the portfolio matures, the cash is paid back to the portfolio to re-invest at the going rate. The beauty of owning a mutual fund is that your dividend will increase as higher paying bonds go into the portfolio.
This is what is happening today: bonds that had been selling at premiums are dropping below that $100 par. They decrease when interest rates go up but will go up when the economy slows and rates decline.
Our opportunity is to add to your bonds over the next year: we will not only buy bonds selling at a discount, but we will see the dividend of your bond portfolio increase. We’ve been earning 1%-2% bond dividends for years but finally, we have an opportunity to increase that to the 3%-4% level. That is money in the bank.
Required Disclosures: Always read the fine print! This content reflects the opinions of Julie Skye and is subject to change without notice and is informational and entertainment purposes. It is not a recommendation regarding the purchase or sale of any security. There is no guarantee that any statements, opinions, or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Securities investing involves risk, including the potential for loss of principal. There is no assurance any investment plan or strategy will be successful.
Julie is an Investment Advisor Representative of Sustainable Advisors Alliance, LLC (SAA, LLC): Advisory services are provided by SAA, LLC.
Registration with the SEC does not imply a certain level of skill or training.