March 6th

I pray this letter finds you and your loved ones healthy. My prayers are with the first responders and the healthcare professionals on the front-line saving lives and protecting ours.

This is the most important letter I have ever written. My hope is you will pass it along to your loved ones and friends because I believe the message is very important.

I have spent my entire career, over thirty years focused on the bond markets. Long-time readers know I have been writing that the latest move in financial assets (stocks, bonds, gold) is the end of something, namely the end of their long-term bull markets. As tens of billions of dollars is now being poured into cash in the form of money market accounts, it appears some may agree, and they may be scared as well.

I know you have a choice with your money, and I appreciate your trust in me and my abilities especially in these volatile times. I believe it is important for you to more fully understand bonds as well as sharing this letter with others who may find it helpful.

In the United States, bonds account for about $33 trillion dollars in assets: US Treasury securities make up about $17 trillion, corporate bonds $10 trillion, mortgages $10 trillion and municipals $3.9 trillion (all courtesy of SIFMA.org). The Federal Reserve has recently increased its balance sheet to $5 trillion, primarily in US Treasuries and mortgages (courtesy federalreserve.gov) leaving a lot of bonds in other’s hands with the bulk either professionally managed including in mutual funds.

Mutual funds, with their quoted net asset values (NAV) and performance data available on the internet may appear to be similar as both can easily be reallocated with a point and a click.  Both have the same disclaimer: “Past success does not guarantee future performance.”  But they are as dissimilar as a stock is from a bond.

All bonds have a maturity date, a maturity value (usually 100) and a coupon (even 0%).  These characteristics are (usually) fixed, hence bonds being referred to as fixed income.  Each day a yield is assigned to each bond from which a price is then calculated.  If yields are high, the calculated bond price results in a low price and a low yield result in high price while a yield closest to zero yields the (near) perfect highest price. This upward limit in price, which is all the cash a bond will ever generate over its entire life, is a huge difference from stock funds in which this calculation can only be guessed at.  But as rates have fallen to near zero, we have moved ever and ever closer to this (almost) perfect pricing.

Look at it this way.  Almost forty years ago interest rates on bonds were double digit resulting in low prices and a long way from the sum of all the bond’s cash flows.  This massive difference was like the distance from Southampton to New York City.  As interest rates fell and time passed the ships moved closer to New York City as the remaining priced in potential of bonds in the portfolio shrunk.  On March 6^th interest rates for all US Treasury securities (from one day to thirty years to maturity) was less than 1%.  The calculated price of all US Treasury securities was therefore almost the sum of all the cash flows these US Treasury securities would EVER pay.  You could sell on March 6^th and receive all your income without waiting to receive it month after month after month.  Though not all bond funds contain only US Treasuries, those other bonds (corporates, mortgages and municipals, primarily) are priced off of them and on March 6^th the spread differential was low, meaning March 6^th was probably a high water price mark for almost all managed bond portfolios.  The ships can see New York City as their prices were so close to perfection on March 6^th.

The objective of a bond fund is generally to invest in bonds “with the primary goal of generating monthly income for investors” (source: Bond fund definition – Investopedia). Bond funds will continue to do this, I have no doubt. But at near zero percent interest rates investors can chose to sell their fund and capture almost all future monthly income today. This is an opportunity for all investors in managed fixed income portfolios that keep score by NAV.

Very rarely do individual investors have such an investment opportunity. Sure, the ship may get closer to New York City and prices become even more perfect. Or the world may change, and the ship hits an iceberg.  Regardless, I believe March 6^th will be the reference point of bond fund’s NAV for years to come.

While your fund’s goal is income, it is unfortunate the fund isn’t telling you this income is already priced into today’s NAV. You don’t have to wait for your income. In fact, waiting may result in tremendous losses.

Austin County, TX

AA S&P Underlying

Due 2/15 Dated 4/1/20 Maturity 2/15/2040

$15,810,000 Sold

1 2021 5.00% 2.60%
2 2022 5.00% 2.65%
3 2023 5.00% 2.70%
4 2024 5.00% 2.73%
5 2025 5.00% 2.75%
6 2026 5.00% 2.80%
7 2027 5.00% 2.85%
8 2028 5.00% 2.90%
9 2029 5.00% 2.95%
10 2030** 3.00% 3.00%
11 2031** 4.00% 3.05%
12 2032** 4.00% 3.10%
13 2033** 3.125% 3.20%
14 2034** 3.25% 3.25%
15 2035** 3.25% 3.30%
16 2036** 3.25% 3.35%
17 2037** 3.375% 3.40%
18 2038** 3.375% 3.43%
19 2039** 3.375% 3.48%
20 2040** 3.375% 3.53%

* Yield to Worst (Call or Maturity) ** Call 2/15/2029

Source: Bloomberg

This is an example of a new issue priced the week of 3/23/20

Prices, yield and availability subject to change