We Are All Traders Now

Over the past couple of months, we have witnessed what it is like to be winners. Investors of stocks and bonds have watched their portfolios move higher with interest rates at or near historic lows, bond prices are unbelievable high. And the effects of high bond prices have reverberated across asset classes.

I pick on bonds because they are “fixed income”. There is only so much income a bond generates (it’s coupon amount) and for only so long (it’s maturity). So, when interest rates are near zero, the price of the bond is approximately, or near, the sum of all of its cash flows (coupons plus maturity or par amount).

A 1% ten year noncallable bond that sold at 100, would be priced at 110 if interest rates moved to 0%. At .50%, the bond would be priced at approximately 105, still a nice 5% gain from no-or-low interest rates to even lower rates.

Such assumptions of low-to-no interest rates for not only a long period of time, but perhaps an inordinate period, certainly had an effect on financial asset prices this summer. At these interest rates, stock prices could conceivably be anything, and sell at infinite-type multiples and indeed some did.

And we were all so blessed to be owners of financial assets, certainly when compared to those that do not, during a pandemic which has literally crushed the hopes and dreams of many.  However, as I continually point out, we have a way to go.

The advantage of higher price trends is no one knows how high is high. The problem is, once we discover the high, it is downhill from there. So here we are again, having to ask ourselves “was that the high”?

So far it has been stocks and gold that have sharply reversed. What is down 5% or perhaps 10% when the market is up so sharply from March? That is true, but down 5% or 10% quickly became down 35% in February/March. We can play these games all day, but the bottom-line for us remains this: the trend has changed.

Going back to bonds, we have not seen bond prices challenge their March highs. Instead we have seen long-term bond prices form a topping pattern over the summer. From a portfolio or statement value point of view, not much seems to be happening in bonds. There has been a lot of bonds issued, a lot of bonds bought and not too many seemingly sold. Bond prices remain near historic high prices, but so far, no real movement.

I expect bond prices to move and again as we saw in March, such movements can be swift and staggering. For bond investors who must continually invest in bonds like the Argyle ISD bonds below, at some point one does the math and determines one can lose many years of income for just a small move in the market. Paying 105 for those 1% bonds in the example above, one can lose 5% if rates move back from .50% to 1%, the equivalent of five years’ worth of income. 

Bond investors must be unbelievably confident that bond prices will not ever move lower if they are buying (or even holding) bonds at these historically high price levels. Indeed, they do!

But why ever hold bonds like those ten-year noncallables? Or even a mutual fund of them? This is the question bond investors must worry about. The problem is not based on your action or inaction. The problem lies with what other bond investors do.

If other bond investors determine the risk/reward is not for them and they sell… as they did in March… it is every other bond investor that suffers. This is the lesson of March. Selling happens, often when you least expect it.

Risk and reward are the elements of the market that are important. The fear of missing out or believing there is no alternative works tremendously well…until it does not. These are markets, and as such they will correct the excesses. Our job is not to be surprised, and better yet, to be prepared.

Washington County Junior College District, TX

Combined Fee Revenue And Refunding, Series 2020

A1 Moody’s Underlying   AA S&P on AGM Insurance

Due 10/1 Dated 9/15/20 Maturity 10/1/43

$27,525,000 Sold

Years   Maturity     Coupon      Yield*

 1            2021           5.00%          0.14%

 2            2022          5.00%           0.20%

 3            2023          5.00%           0.30%

 4            2024          5.00%           0.35%

 5            2025          5.00%           0.40%

 6            2026          5.00%           0.65%

 7            2027          5.00%           0.85%

 8            2028          5.00%           1.00%

 9            2029          5.00%           1.10%

 10          2030          5.00%           1.20%

 11          2031**      4.00%           1.30%

 12          2032**      4.00%           1.40%

 14          2034**      2.00%           2.00%

 15          2035**      2.00%           2.10%

 16          2036**      2.125%         2.15%

 17          2037**      2.125%         2.20%

 18          2038**      2.25%           2.25%

 19          2039**      2.25%           2.30%

 20          2040**      2.25%           2.35%

 25          2045**      4.00%           1.56%

*Yield to Worst (Call or Maturity) ** Call 10/1/30

Source: Bloomberg

This is an example of a new issue priced the week of 9/15/20

Prices, yield and availability subject to change