July 21, 2003
We were astounded when we saw the following poll
results:
"Bethesda, Md. - June 26 - A survey conducted by Harris
Interactive on behalf of ProFund Advisors LLC finds that, although most
U. S. investors (57%) believe interest rates will rise in the next two
years, nearly two-thirds (65%) are unaware that rising rates generally
have a negative impact on the value of bond investments."
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WHAT'S WRONG WITH THIS PICTURE?
"GM bonds tap into 'wall of money'" according to the
June 27th Financial Times which then reports "Car giant benefits from
buying frenzy as cash-rich investors ignore shares and scramble to buy
bonds in search of higher returns."
On June 26th GM sold $17 Billion of bonds - the largest
amount of bonds ever sold in the corporate debt markets. The purpose, in
large part, was to offset about $20 billion of GM's unfunded pension
liabilities.
Later from the FT article: "Disillusionment with
slumping stock markets has caused investors to migrate in droves toward
the bond market, with the result that fund managers have mounting piles
of cash waiting to be invested but not enough new bond issues to absorb
it. And the dramatic decline in interest rates is making investors
increasingly desperate for yield."
Total orders for the GM and GMAC, its financing arm,
amounted to $30 billion with European demand strongest in the 30-year
bonds. The bonds apparently appeared to be extraordinarily attractive
investments because of their yield. The GM 10 year bonds were priced to
yield 7.22% --- 3.75% over US Treasury bonds having the same life. The
30-year bonds were priced to yield 8.5%, about 4% higher than the
Treasury having the same maturity.
In March 2000 stocks never looked better than when they
were at their all time highs. We were on record long before then and
subsequently as having warned many times about the incredible stock
bubble. Please see "Commentaries" on our Web site
www.hamiltonadvisors.com.
Our economy still has not picked up satisfactorily
since the attacks of September 11th. Interest rates, largely as a result
of the Federal Reserve's efforts to stimulate the economy, are now at
45-year lows as the US base interest rate is 1%. Bank deposit rates are
0.5% and taxable money market funds yielded 0.64% on June 24th, an all
time low according to iMoneyNet.
It is interesting to note that Elizabeth Krauss, a
managing director at State Street Research & Management, recently said
"we stand by our commitment to shareholders" a promise by State Street
Research that will keep the (money) fund's yield at no less than 0.10%.
(WSJ - June 26)
On Friday, June 13th, the 5-year Treasury note closed
at 2.029% - almost 2% - its lowest level since January 1955. The 10-year
closed at 3.10% - almost 3% - its lowest level since July 1956. And the
30-year Treasury bond closed at 4.17% - close to 4%.
These yields were, as mentioned, on June 13th, eight
business days before the GM sale on June 26th.
As of this writing the 5-year Treasury yields 3%, the
10-year at 4.14% and the 30-year at 5.04%. These moves from June 13th to
July 21st are highly noteworthy at the very least. We cannot calculate
the billions lost in bonds in this very short period and speculate about
the 65% of Americans in the June 26th Harris Interactive survey
mentioned at the very beginning who are "unaware that rising rates
generally have a negative impact on the value of bond investments."
The long and short of it is that we could very
significantly increase the nominal yield on portfolios if we
Bought bonds having longer maturities, and
Bought bonds having a lower credit rating.
Example: GM bonds having a maturity of 30 years, a
marginally higher rating than "junk" (BBB) and a yield to maturity of
8.5% on June 26, 2003.
We note that the largest demand for the GM bonds was
for those that had a maturity of 30 years, the longest maturity offered.
Also note that the feeding frenzy for GM's bonds was by
investors who obviously were/are no longer risk averse as General Motors
is rated BBB --- only two notches above the rating for junk bonds.
GM bonds were sold to buyers who were in a frenzy to
buy bonds 1) having a long life 2) having a much lower than "investment
grade" rating at a time when the bond markets were at or close to all
time highs.
Aside from professional traders, many of the GM/GMAC
bond buyers have chosen to disregard the bonds' inherent risk or don't
care about taking large risk in their frenzy for higher yields. It is
possible that some simply do not understand the risk they are taking
when bond prices were at 45-year highs. Just like the buyers of stocks
at their all time highs in the March 2000 era.
We have not and will not do that to our clients.
We have been increasing the percentage of stocks in
clients' portfolios in recent months. However, several not insignificant
problems continue to be the facts that
- The economy still has not shown the beginning of credible recovery
in many areas that would lead to increases in companies' earnings
necessary to support a sustainable higher stock market; and
- Many of the stocks we want to buy are still not attractive buys in
terms of their market price vis-a-vis their fundamental value. In
other words, they are not cheap.
Some traders call this an ABC market. Anything But
Cash.
The general tone of the stock markets has been
improving, and we hope it will continue although the casino mentality is
beginning to surface once again as hot money drives up small company
shares. While being pleased with the recent improvements in the markets,
we are using caution as our foremost objective continues to be
Preservation of Capital.
Keep in mind the fact that Alan Greenspan and his
colleagues at the Fed have not continued to lower interest rates because
they see signs of Economic Irrational Exuberance.
The must-win bet is on a U. S. economic recovery.
Meanwhile, cash is indeed trying to be Anything But
Cash.
John W. Hamilton
July 21, 2003
