Evaporating Asset Prices

Another down week on Wall Street but who is counting? Obviously, everyone because we know that number to now be six, as in six weeks. But I digress as I am a bond guy so let me keep on task. Another down week for bonds, all told close to 110 now since the top in bond prices, but who is counting… besides me?

This week we set new lows in price for the bellwether ten-year and thirty-year U.S. Treasury note and bond. Now those unprecedented year to date bond returns we saw last month are even more unprecedented. The worst ever start for US treasuries is beginning to be felt in other markets.

Thus far market prices have simply evaporated. Some call this orderly; others call it a reset. Stock prices for companies that were formerly considered home runs (think Peloton, PTON) have now retraced all their home run up. From a $18 low in March 2020 to $171 in January 2021 and below $12 last week (per Bloomberg), PTON does not stand alone with this chart. You can find other stocks and ETFs have similar looking charts. There is a lesson here: only sell the stocks you want to record a gain because later you might not have one.

But back to bonds. Unlike stocks, where values are created or destroyed based on the share price of the last share traded, bond prices can evaporate without any such trading. Think about that. And think about it some more because, in my opinion, it is bond pricing that is wreaking havoc with asset prices.

Our Federal Reserve did not accidentally affect bonds such that interest rates plunged to near zero and bond prices correspondingly soared to the greatest (or near greatest) heights in price. No, this was the plan to jumpstart a shutdown economy in March 2020. The myriad side effect of these actions included a skyrocketing stock market as well as tremendous optimism, also known as the wealth effect. And if the Federal Reserve chose to use its additional “tools” to purchase trillions of dollars in bonds to raise their prices further and move more cash out into the economy, then we would just have to live with those repercussions as well.

You know my response. Sell. Sell all things bonds that are managed and work like generic bonds: mutual funds and ETFs primarily. Bond prices have evaporated not because investors are running for the exits. Bond prices evaporate because bonds are priced on a spread grid, largely influenced by the yields on US treasury securities including the bellwether note and bond we follow. As treasuries go, so go the spread products of corporate bonds, municipal bonds, and mortgages.

We are all long-term investors, and we know we need to remain calm and ride this out. No! We should have sold our bonds and ETF’s years ago because higher interest rates will make those funds and ETFs worth less. All without much investor selling at all.

Years ago, I believed that investors would see higher interest rates coming and sell. Crazy, I know. I wrote pieces proclaiming, “There will be selling,” an ode to “There will be blood,” but what do I know. Investors have not rushed to sell bonds. Yet we have one of the worst (the worst?) four-to-five-month performance figures in bonds EVER! Think about that. Think about that some more.

One of the current parlor games on Wall Street is guessing how high interest rates will go to affect the Federal Reserve’s latest objective: bringing down inflation. What a waste of time. Instead let us focus on how bond prices behave in a bear market. For this exercise I will rely on my intimate history with trading junk bonds of The Southland Corporation (7-Eleven) and The Zale Corporation in the early 1990s. Both companies, founded here in Dallas, saw their near double digit coupon debt (8 to 10% coupons if memory serves me) ultimately tumble into a bankruptcy and ultimately reorganization.

In a bear market where bond prices begin their life near 100, or even a premium, and ultimately trade at twenty or below, there is a pattern with many of them. While certainly not original, the pattern is a first decline from 100 to somewhere cheaper, say 70 to 80. This initial decline is obviously between 20% and 30% and serves as a nice warning shot across the bow. Other investors, perhaps of the buy-the-dip mindset, enter the trade bidding prices back up to say 90. This is the correction phase. Then the fun begins when prices slide below 70 again. This is because there is not much difference between a 65 price and a 25 price (except 40 points and much greater than that relatively) because a troubled bond is a troubled bond, and you best not own it (it is too early).

My point in writing these monthly missives is not to entertain you or me. I am writing to convey ideas that have larger implications for you. Bonds are in a bear market, and this has occurred without widespread selling. Greater implications are cascading through the markets as higher interest rates and less liquidity are having huge impacts across all markets.

As I have previously discussed, the behemoth financial industry, of which I am a part, will spend whatever it takes to continue to convince you and other investors to continue investing more of your money. So far, they have been very successful regarding bonds (no panic here). Nonetheless, the best time to exit a market, any market that is rolling over, is before others.

Markets do not move in one direction. They advance and then they correct. Everyone (it seems) expects bonds to correct, even if just to continue their downward trend in price. That does not mean a bounce imminent even after two years, or two years and one month, or now, at two years and two months.

While I was wrong about “There will be selling,” the result has been the same: lower bond prices and horrible bond performance. There is, however, an idea from one of my letters a while back: “We are all traders now.” Indeed, and the sooner you realize this, I believe, the better off you will be financially. Asset prices are on the move and those who know how to sell should do well in this current market environment. Think Mark Cuban (sorry Warren Buffett) and Go Mavericks!

Richardson Independent School District, TX

Unlimited Tax School Building Bonds, Series 2022

Aaa Moody Underlying AA+ S&P Underlying

Aaa/AAA/NR on PSF Guarantee

Due 2/15   Dated 6/1/22 Maturity 2/15/47

$192,025,000 Sold

Years   Maturity           Coupon      Yield*

1         2023             5.00%           1.94%

2         2024             5.00%           2.33%

3         2025             5.00%           2.51%

4         2026             5.00%           2.62%

5         2027             5.00%           2.68%

6         2028             5.00%           2.78%

7         2029             5.00%           2.87%

8         2030             5.00%           2.99%

9         2031            5.00%           3.06%

10       2032**          5.00%           3.09%

11       2033**          5.00%           3.15%

12          2034**        5.00%           3.19%

13          2035**        5.00%           3.25%

14          2036**        5.00%           3.29%

15          2037**        4.00%           3.60%

16          2038**        4.00%           3.64%

17          2039**        4.00%           3.68%

18          2040**        4.00%           3.71%

19          2041**        3.875%         3.91%

20          2042**       3.875%        3.93%

23          2047**       4.00%           3.94%

*Yield to Worst (Call or Maturity) ** Call 2/15/31

Source: Bloomberg

This is an example of a new issue priced the week of 5/9/22

Prices, yields and availability subject to change

This Letter Originally Published 5/18/22