(PRWEB) November 26, 2004
Corby Capital Markets, the fixed income broker dealer based in Boston, is addressing investorÂs concerns about investing in bonds at prevailing rates. In their recent newsletter ÂThe Bond SpecialistÂ, Michael E. Shamosh, President of Compound Strategies tells bond investors sitting in cash that they are suffering from what he calls ÂCompound Fracture.Â
At the beginning of this year there was virtually no one who liked the bond market. Watch the morning business news and a parade of ÂknowledgeableÂ guests would warn you off of the bond market. Step out in the street and ask a neighbor about interest rates and the reply would be Âthey are going upÂ. On your daily commute there were more signs of the impending bond market debacle. ÂRefinance now before rates go upÂ could be seen on the billboards, buses and trains. Walk into the building in which you work and, you might think you hear Âgood day sir, rates are going upÂ from the security guard.
One thing about markets; they do not care what you think. Instead of higher rates the majority of bond market professionals, and not a few small investors, wound up with a case of Âcompound fractureÂ. Instead of using the power of compound interest, the way most bond money is made in this world, investors broke the chain of compounding by sitting in cash and money funds at rates below the rate of inflation. Everybody waited for a day that has not come; at least not yet.
Compound fracture is a serious problem whether it be medical or monetary. A badly broken femur will stop you from getting where you want to go; a broken chain of compounding will do the same. Unless you are using the incoming cash from your portfolio for living expenses, it should be treated as a source of future money growth.
A quick illustration can show just how significant compounding is to bond market returns. LetÂs say you purchased $100,000 worth of a twenty year bond at a yield to maturity of 5%. That means you expect your money to grow at 5% for twenty years which will turn your $100,000 investment into $268,506. The components of that final number are as follows:
Return of original investment $100,000
Coupon payments $ 100,000
Interest on interest @ 5% $68,506
If, instead of reinvesting at 5% the interest is reinvested at a money market rate of 1%, then the interest on interest falls to $171,964 and the bondÂs total return falls from 5% to 3.93%.
All this really means is that sitting around waiting for higher yields could be a big mistake as money market yields remain below the inflation rate. It certainly has not been the correct strategy for this year.
Those gurus and assorted talking heads are right about one thing; rates have moved up. The Federal Reserve, for its own reasons, has now raised the interest rate it charges its member banks to borrow three times this year. This rate is an overnight rate for banks that is often confused with the general level of interest rates in the economy. At the same time long-term bond rates, the rates which most borrowers pay have come down. The yield curve, that graphic interpretation of interest rates at differing maturities, has flattened. That is, in fact what happened in the three episodes of rate rises by the Federal Reserve since 1980. We expect more of that going forward as the stimulus shocks wear off. Long term yields remain above the rate of inflation while money market yields are below.
The bond market is telling us something. It is telling us to expect no boom this time around. The largest array of stimuli applied to the American economy in recent memory (tax cuts, low short-term interest rates, government spending) has produced modest growth and some more inflation. It is the Âprogesterone economyÂ, pumped up to a point of disfigurement (high trade and budget deficits) to ward off the potentially lethal disease of a debt deflation.
A debt deflation is the paying down of debt in an economy which results in a contraction of output and falling prices. Think 1990s Japan. Nobody wants that. Yet it takes ever increasing amounts of credit growth to produce a unit of gross domestic product (GDP). A dollar of credit today produces less than 25cents of GDP. Our 1950s parents got three times that performance. In the words of a Peggy Lee ballad ÂIs That All There Is?Â.
In recent months there were many pundit pronouncements calling for the Âend of the bond bull marketÂ. Maybe they will be correct and maybe not. However you should remember they are talking about price, that bond prices will decline. This begs several questions.
1) How will such a leveraged economy be able to sustain higher rates?
2) At what rate will prices drop (yields rise) ?
3) Will it be a secular (long-term) or cyclical rise in yields?
There are lots of opinions about bond yields but only one certainty: Higher yields enable you to compound at a higher rate.That means the bull market in bond prices may, or may not, be over but the bull market in compounding goes on.
About Corby Capital Markets, Inc
Established in 1975, Corby Capital Markets is a nationally recognized leader in the investment, underwriting and distribution of fixed-income securities. Corby Capital Markets provides private investors, bank trust departments, investment counseling firms, money managers and insurance companies with exceptional access to a broad range of domestic fixed-income markets including municipal bonds, government agencies, corporate bonds and mortgage-backed securities. Corby Capital Markets is locally owned and operated, with a particular commitment to New England. Corby Capital Markets is a member of the NASD. For more information, call 617-482-8780 or visit http://www.corbycapital.com.
The information provided is neither financial advice nor a recommendation, offer, or solicitation to engage in a financial transaction. Corby Capital Markets, Inc. makes no representation concerning its accuracy, completeness or fairness. The past performance of a market measure or instrument does not guarantee or predict future performance. Opinions and estimates may change without notice. The trade ideas described in this document are not appropriate for everyone, so a party must make its own independent legal, tax, accounting, and financial evaluation of the merits and risks of such ideas before seeking to implement them. This information should not be reproduced or circulated without Corby Capital Markets' express written consent. Furthermore, all offerings are subject as to availability and pricing.
Corby Capital Markets, Inc. 10 High Street Boston, MA 02110
Tim Coffin, President
Tel: 617-482-8780, 1-800-736-7076
Michael Shamosh, President
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