At our 14th Annual Investment U Conference at the beautiful Grand Del Mar in San Diego last week, I discussed a number of attractive investment opportunities available right now.

But I also warned them about one of the worst investments you can make. Take a minute now to make sure you don’t have it in your portfolio right now.

As I mentioned in a recent Investment U column, we’re at the tail end of the biggest 30-year rally in bonds the nation has ever seen. Three decades ago, Fed Chairman Paul Volcker pushed the prime rate up to 21.5% to squelch inflation. Long-term Treasury yields reached 16%. From that pinnacle, long-term yields have plummeted to 3.1% today. Bond prices have soared accordingly.

But the financial crisis is over and the economy is beginning to show a pulse. Higher inflation may be just around the curve. And as yields move up, bond prices move down. And perhaps way down.

Just about the worst thing you can own when interest rates are moving up is a leveraged bond fund. When a fund manager borrows short term at low rates in order to buy additional long-term fixed-income investments for his fund, it’s the equivalent of buying stocks on margin. It works fine while bond prices are flat or rising. But when bond prices fall – as they will when interest rates rise – these shareholders take a shellacking. If you’re not sure whether the bond funds you own are leveraged, don’t guess. Call the funds and ask.

And if you owned a leveraged closed-end fund, don’t even call. Just get out, especially if the fund is trading at a premium to its net asset value (NAV).

Recall that closed-end funds are not like Fidelity or Vanguard mutual funds. Like ETFs, they trade on an exchange and can be bought and sold throughout the day (not simply redeemed at the closing price like open-end mutual funds).

However, closed-end funds can see their prices fluctuate well above or below their net asset values (NAV). When a fund trades above its NAV, it is said to be trading at a premium. And when it trades below the NAV, it is trading at a discount.

There is no easier (or more obvious) buy or sell signal than to buy these funds when they trade at big discounts and sell them when they go to a premium.

If those premiums are huge – as many are in the fixed-income sector right now – they are ticking time bombs that you definitely don’t want in your portfolio. Here are just a few that are particularly dangerous right now:

And then there is the biggest stink bomb of them all: PIMCO High Income Fund (NYSE: PHK), currently trading at a 60.4% premium to its net asset value. Over 60%! That is completely nuts. These shareholders are clearly asleep – and overdue for a rude awakening.

Even if your closed-end funds aren’t on this list, don’t be complacent. Call your mutual fund and ask if the manager is using leverage. Or visit a free website like www.cefconnect.com and check out the relationship of your closed-end funds to their net asset values.

It may well be the most important three minutes you spend on your portfolio this year.

Good Investing,

Alexander Green

Bond, Business/Finance, Chairman, Chief Investment Strategist, Closed-end fund, Exchange-traded fund, Finance, Financial economics, Financial services, Funds, Futures contract, hedge fund, Interest rate, investment, Long-Term Capital Management, Mutual fund, Net asset value, Open-end fund, Paul Volcker, San Diego, US Federal Reserve

Investing in Bonds: Three Steps to Smarter Bond Investing
by Alexander Green, Investment U Chief Investment Strategist
Monday, March 5, 2012: Issue #1722

At our Oxford Club Chairman’s Circle conference at The Ritz-Carlton in Naples last week, I noted a decided optimism about the outlook for the bond market. This enthusiasm is almost certainly misplaced.

We’re at the tail end of the biggest 30-year rally in bonds the nation has ever seen. Recall that three decades ago, Fed Chairman Paul Volcker pushed the prime rate all the way up to 21.5% to squelch inflation. Long-term Treasury yields reached 16%. But from that pinnacle, long-term yields have plummeted to around 3% today. Bond prices have soared accordingly.

It isn’t just unlikely that today’s bond buyers will see annual double-digit returns going forward, it’s mathematically impossible. And yet I sense that many fixed-income investors don’t understand this.

It’s not unusual to meet an investor who has plunked money in a bond fund because “its long-term track record is excellent.” They don’t seem to realize that it’s also irrelevant. Never has the old saw, “Past returns are no guarantee of future results,” been more apropos.

This doesn’t mean you should avoid bonds altogether, of course. But if you’re going to buy bonds, now more than ever you need to be smart about it. Here’s what you should do:

1. Ladder your maturities. You should buy two-year, five-year and 10-year bonds. If rates go up – as they will eventually – your bond prices will fall, temporarily. But you will get your principal back at maturity and be able to reinvest your principal at higher rates. And paltry as bond yields are today, they still beat the heck out of the 0.05% that the average money market fund is paying.
2. Keep a close eye on expenses. In the world of fixed-income investing, keeping a Scrooge-like eye on expenses is essential. Why? Because it’s difficult to work magic in the button-down world of fixed-income investing. Managers rarely earn their fees. And 12b-1 fees can eat away at your returns like termites in an antebellum house. My advice is to stick with individual bonds, Vanguard funds (whose expenses are one-sixth of the industry average) and low-cost ETFs.
3. Avoid leveraged bond funds. Ever wonder how bond yields can be so low and yet the yield on your closed- or open-end bond fund is higher, even after expenses? Open your eyes. Unless you’re holding junk bonds, your fund manager is using leverage, the fixed-income equivalent of buying stocks on margin. By borrowing cheap, he or she is leveraging the portfolio to add yield. This works just fine while bond prices are flat or rising. But when bond prices fall – as they will when interest rates rise – these shareholders will take a shellacking. Consider yourself forewarned.

Some fixed-income investors tell me they feel safe for now since Bernanke has pledged to keep interest rates low through 2014. Think again. The Fed has only announced its intention to keep rates low. (Future economic conditions could quickly change that.) The Fed is also keeping long-term bond yields artificially low by buying these instruments to goose the economy.

Inflation could tick up. The Fed could raise rates and/or quit buying long-term Treasuries. In the end, the Federal Reserve sets short-term interest rates, but not bond yields and prices.

Know this. Understand it. And act accordingly. Bond investors today should be in a defensive posture, capturing higher yields than what’s available in cash instruments, but prepared for that point in the future when bond yields will rise and prices will fall.

Good Investing,

Alexander Green

Bonds, Business/Finance, Chairman, Chief Investment Strategist, Economics, Federal Reserve System, Finance, Fixed income analysis, Fixed income market, Futures contract, inflation, Interest, Mathematical finance, monetary policy, Naples, Oxford Club, Paul Volcker, Rate of return, United States Treasury security, US Federal Reserve, Yield, Yield curve

Buying Stocks: Don’t Succumb to The Siren Song of the Naysayers

by Alexander Green, Chief Investment Strategist
Wednesday, August 11, 2010: Issue #1321

Comedian Dennis Miller used to joke that he was at the airport when his ship came in.

A year from now, plenty of investors are likely to feel the same way. Why?

Because they’re ignoring the good news out there right now and not buying stocks. Instead they’re succumbing to the siren song of the naysayers.

And while no one can know for certain what the stock market will do in the year ahead, there are good reasons to believe that stocks may be substantially higher.

That’s because there are two traditional indicators that investors are wise to heed:

• Don’t fight the Fed
• Don’t fight the tape

Let’s take a closer look at each of these and I’ll show you why…

Don’t Battle with Bernanke

As we all know, the Federal Reserve has taken short-term interest rates to near zero. Moreover, Fed Chairman Bernanke has repeatedly said that he expects to keep them there “for an extended period.”

This is a green light for Fed-watchers. Low interest rates…

• Make it cheaper for corporations to borrow.
• Reduce the cost of owning stocks on margin.
• Make cash and time deposits unattractive relative to stocks.

A stock investor today certainly isn’t fighting the Fed.

Let’s take a closer look at the “don’t fight the tape” part…

Don’t Fight the Tape

The stock market is in a confirmed uptrend. Seventeen months ago, the Dow bottomed near 6,500. It has had its ups and down this year, but the big trend is up, not down.

• If you’re buying stocks, you’re with the tape.
• If you’re short the market or out of stocks, you’re fighting the tape. And that’s not good.

(The tape, of course, is a reference to the ticker tape of yore.)

Some investors tell me they’re not comfortable buying stocks during a recession.

Hello?

It’s true we’re not experiencing robust economic growth. But a recession is defined as two consecutive quarters of negative economic growth. We haven’t had a single negative quarter in the past year. In fact, GDP growth has averaged 2.84% a quarter over the past 12 months.

It doesn’t feel that way, of course, because housing is in a funk, unemployment is high and consumers are reluctant to spend. But for the third consecutive quarter, profits have mostly beaten expectations.

Why? Partly because companies have laid off unnecessary personnel, refinanced debt at lower levels and cut other costs. Even a modest uptick in revenue is causing a big jump in bottom-line profits.

Plus, businesses are benefiting from technological innovation, negligible inflation and booming new markets overseas, particularly in Asia and Latin America.

Feel the Fear… And Buy Stocks Anyway

Other investors tell me they can’t buy stocks because there is just so much gloom and doom out there.

Apparently, they don’t realize that negative sentiment is a powerful contrary indicator. (Or as Warren Buffett often says, you want to be fearful when other investors are greedy and greedy when others are fearful. And without a doubt, investors are fearful right now.)

Of course, there is a lot of negativity because this is an election year, too. Republicans are talking up how bad things are to increase their chances in November. Democrats are conceding that things are bad – and still blaming things on Bush – because they don’t want to seem out of touch.

Indeed, there is plenty to dislike about how the folks in Washington are running the show. But a decision to buy stocks is not an endorsement of any political party or a statement that all is right with the world. It’s merely an acknowledgement that business conditions – and profits – are likely to improve in the future.

If you disagree, that’s fine. But at least concede that you’re fighting the Fed, fighting the tape – and fighting the sentiment indicator.

Historically, that has not been a profitable strategy.

Good investing,

Alexander Green

ben bernanke, Business, Business/Finance, Finance, Financial economics, P/E ratio, Short, Stock market, US Federal Reserve