Bond vigilantes waterboard investors, markets whacked again


WASHINGTON, June 25, 2013 — Wall Street looks to take a brief break from its Mad Slasher ways today, due, according to the punditocracy, to an impressive Case-Shiller Home Price report. According to CNBC, “U.S. home prices took a major leap in April, setting a new monthly record for gains. From March to April, home price gained 2.6 percent and 2.5 percent for the top ten and top 20 U.S. markets respectively, according to the latest S&P/Case-Shiller Home Price Indices. Average prices rose 11.6 percent and 12.1 percent in April from a year ago.”

The happy talk continued. “‘The recovery is definitely broad based,’ said David Blitzer of S&P Dow Jones in a release. ‘The two composites showed the largest year-over-year gains in seven years.’”

That’s nice and everything, but the HFTs that are ready to trade this news and spike the market up this morning, at least briefly, are not looking ahead to the fact that, with current interest rates rising, at least short term, May’s numbers, to be reported next month, aren’t looking so hot, with home prices in many non-urban areas across the country taking a significant hit.

We wouldn’t like to be in housing stocks when that news gets reported in late July. But then again, this could be a quick trade for those who don’t have to worry about a day job. Or the HFTs, for that matter.

More profound has been the horrendous action in the bond market, of which the Maven, alas, has been another casualty. We’ve mentioned here for some time that we have a modest legacy bond position dating from a risky move we took in March 2009, buying a small batch of B-rated bonds for huge discounts from face value. Bearing abnormally high interest coupons, these bonds have soared since then, giving us paper profits in some instances in excess of 50 percent—almost unheard-of in the generally boring world of bonds.

Calculating minimum yield-to-maturity, plus the sheer inherent value of high interest payoffs in a low-inflation environment, we’ve held on to these bonds for years. Even though they’re trading significantly above par ($1,000 per bond) now, we figured if we waited until they matured, the outsize interest plus the capital gains would be more than worth the simple gains we could have taken a couple of months ago had we sold them.

We are now second-guessing ourselves a bit. All these bonds are still above par. But over the last few trading days, they’ve taken a tremendous haircut—particularly yesterday—taking a nice chunk of value out of our overall portfolio; the first time we’ve experienced this, at least to this extent, since 2009. It’s disconcerting. But then again, it was bound to happen anyway, albeit in slo-mo.

Even a strong premium-priced bond will start to sink toward par value as it approaches maturity, and a good 90 percent of our bond purchases had been of issues with ten years or less to go to maturity, that dating from 2009. So what we have left will mature between now and about 2016, with two issues expiring in 2019.

We do have two issues that are longer term, but they constitute so little of our portfolio, percentage-wise, that we don’t have a problem holding them anyway. One of them is a bizarre, little-known issue that has great meaning for us here in the DC area, a DC Metropolitan Airport Authority bond with a 5 percent coupon maturing in 1929. It’s thinly traded, but to us, at least, that’s a wonder.

The Metropolitan Airport Authority is actually an all-Virginia entity that somehow managed to float this issue as DC paper, which means that, as a muni bond, not only is its interest Federal tax exempt. It’s tax exempt for any holder in any state since the muni bonds of DC, like those of Puerto Rico and the Virgin Islands, are also tax-exempt in all states by statute, making them attractive to anyone.

Safety-wise, they’re also insured by Warren Buffett’s Berkshire Hathaway itself, or at least the entity that Uncle Warren put together during the collapse of the muni bond insurers—fallout from the continuing bond insurance debacle. We’ve heard Buffett is no longer offering this insurance to new bond issues, but he’s on the hook for this one.

The bonds are actually meant to support, in part, the construction of the DC Metro’s new Silver Line out to and slightly beyond Dulles Airport, a long-needed area transportation improvement. Plus, they’re callable starting in 2019, with a mandatory sinking fund meant as an aid in retiring them early.

In other words, there’s no reason why muni bond buyers shouldn’t be all over this one. Except that they aren’t and never have been. Plus, the bond’s price, which had soared to a premium as high as $129. That’s $1,290 in bond parlance, a full $290 premium above par per bond, with a minimum usual purchase of at least $5,000 in face value.

Alas, in the course of just a week, that premium has done a Wile E. Coyote cliff dive, falling to a price of $104 yesterday—just a $4.00 premium over par. It’s quite a disastrous drop, but it’s a prime example of what’s been happening in the wonderful and usually boring world of bonds over the past couple of weeks.

As holders of these bonds and others, we lament this collapse, particularly given the swiftness of the fall and the damage to our portfolio. On the other hand, getting $500 in interest every year through at least 2019 does cushion the fall, particularly when we don’t have to pay taxes on this particular issue’s interest.

That said, after a nearly 30-year rally in bonds, the end may finally be nearing for this run, as the past two-week’s action has amply indicated. We’re going to grit our teeth and hold these puppies since we’re still way ahead. But the action here has got to be a sobering reminder that even a hint from the Fed that its low interest-rate party might end some day has sent the HFTs and hedgies into a tizzy of selling, making the near-term pain for the average older investor or retirement portfolio—usually bond-heavy—considerable.

There will likely be a pause in this downside action today, considering that it’s already way overdone. But picking up any new or existing bond issues, even those with five years or less to run to maturity, is still awfully risky, as is gaining exposure to them through HFTs, closed-end funds, or unit-style trusts.

In other words, investing in anything pretty much anything except cash and money market funds is still quite risky in this volatile market environment. With Barack Obama losing control of U.S. influence internationally due to a feckless, post-colonial-style foreign policy, and with Ben Bernanke’s Fed having lost the confidence of the bond market last week, with the concurrent rise of the long dormant bond vigilantes, the whole investing environment remains quite treacherous. So once again today, we won’t venture any recommendations at all except to hold cash and start attending church services again.

*NOTE: U.S. Savings Bonds, pictured above, don’t really enter into this discussion, as they’re different from the tradable variety. That said, this image does promote the safety of interest-bearing investments in general. Unfortunately, that hasn’t been the experience of bond investors this week. Since they’re generally a fiscally conservative lot, this has to be quite disconcerting, contributing to the gloomy tone investors of all stripes have had to contend with since roughly 2007.


Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate.

Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.

Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.

References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.

Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.

Follow Terry on Twitter @terryp17


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Terry Ponick
Biographical Note: Dateline Award-winning music and theater critic for The Connection Newspapers and the Reston-Fairfax Times, Terry was the music critic for the Washington Times print edition (1994-2010) and online Communities (2010-2014). Since 2014, he has been the Business and Entertainment Editor for Communities Digital News (CDN). A former stockbroker and a writer and editor with many interests, he served as editor under contract from the White House Office of Science and Technology Policy (OSTP) and continues to write on science and business topics. He is a graduate of Georgetown University (BA, MA) and the University of South Carolina where he was awarded a Ph.D. in English and American Literature and co-founded one of the earliest Writing Labs in the country. Twitter: @terryp17