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Stocks are dead for the rest of your life.

Recs

27

February 26, 2009 – Comments (18)

 

I have become particularly fascinated with PIMCO's Bill Gross lately.  No, I'm not going to go all "Single White Female" and start wearing my hair in a weird comb-over.  I just believe that he is one of the most influential, intelligent investors out there right now.  Many people don't realize just how much influence Mr. Gross has.  I encourage everyone to read the outstanding article about PIMCO and Gross that appears in this month's Fortune magazine to see what I am talking about:

Pimco's power play

Bill Gross is deftly navigating the most treacherous market in modern times. But is the bond king too big? Does he have Washington - and us - over a barrel?

I just came across an interesting follow-up article on a new (at least I think that it's new, I've never seen it before) AOL site called Daily Finance this afternoon, Bill Gross, the $747 billion bond man, declares the death of equities.  The first line of the article is certainly attention-grabbing, "Stocks are dead for the rest of your life." 

I am definitely taking Gross' thoughts on this subject with a grain of salt.  He is notorious for talking his book as they say in the industry and as possibly the world's most powerful bond investor he certainly will benefit if stocks take a back seat to bonds.  Having said this, his opinions on the subject are definitely worth reading.  Here are a few quotes:

In Gross's view, the current economic contraction is killing the animal spirits that drive risk taking and that's contributing to the death of equity capitalism as we've come to know it..."things will never be the same. Risk taking has been destroyed and any animal spirits must come from Washington. Global growth rates -- low, low, low -- asset classes will be readjusted for that outlook. That is -- stocks will be more of a subordinated income vehicle as opposed to a 'stocks for the long run' growth vehicle."

And in Gross's view, growth prospects are so dim that there is no point in owning stocks since common stock investors will not benefit when there's no economic growth. Moreover, they'll be last in line for any dividends that might be available.

Meanwhile, Gross has an interesting analysis of how we got into this mess. He attributes it to too much borrowing, weak regulation and greed. He also thinks that the U.S. is going to have to come up with as much as $5 trillion to fill the capital hole in the banking system.

As Gross said, "The cause of the current situation was too much leverage leading to over consumption which was facilitated by lax regulation and good ol' fashioned greed. Human nature will never change but our institutions will. Not sure policymakers understand what needs to be done -- there still is a $4 trillion to $5 trillion capital hole that needs to be filled but politics may inhibit necessary action. Bernanke and Co. get it though and have more freedom and flexibility -- they are independent -- for now."

Gross certainly is right in one respect, common stock is at the bottom of the totem poll in the capital structure of companies.  In the event of bankruptcy, holders of common stock almost always get completely wiped out.  Bondholders and even the owners of preferred shares get paid out first when a company's assets are liquidated. 

Furthermore, dividend-paying companies that run into financial difficulty stop paying divies on common stock before they stop paying them on preferred stock and bonds (yes I realize that payments on bonds are technically interest, not dividends, but you get the point). 

The increased safety of bonds and the security of their payouts is the reason that I have completely limited my investments to them and preferred stock, mostly the former, over the past several months.

As some background about my interest in the area, I was personally was heavily involved in investing in bonds years ago, until all of the leverage, arbitrage, and hedge funds in the system made risk premiums on bonds almost nonexistent.  I finally decided to move away from bonds at that time.  The debt for some really scary companies, like the domestic automakers, was trading at such a small premium to much safer things that I just could not get the yields that I felt were necessary. 

Flash forward to today.  The leverage is being slowly wrung out of the system and people are scared.  While fear is a bad thing for consumer confidence and equities, it is a great thing for bonds.  Even with the Federal Funds rate as low as it is, I am seeing bonds out there right now with amazing yields.  I have been able to pick up bonds in companies that were considered bulletproof, like Alcoa, Dow Chemical, Corning, Goldman Sachs, and JP Morgan Chase to name a few that sport yields of near, or even greater than 10%+.  The Hidden Gems rec Montpillier Re has reasonably short term debt out there that has a 13% yield to maturity.   

Bonds don't have to be completely boring either.  To keep myself entertained, I've even taken a few small, short-term fliers on some really messed up stuff like Textron and BofA.  I could go on and on about the interesting issues that are available out there. 

If you think that the economy is a mess and will likely get worse for the next year, like I do, there's no logical reason to step in front of that freight train and purchase common stock. Even if you say that you are buying for the long-run, why do so now when things will likely be cheaper several months down the road.  The state of the economy is a crucial element to how companies perform. Continued economic weakness will be an absolute nightmare for the common stock of many companies.

I'm not saying to abstain from investing during times of weakness, just to be more careful. At this point, I'm not looking to hit any home runs. I have been spreading out my bets and buying things that are fairly high up the capital ladder like preferred stock and bonds with yields from 9% to 11%. Most of the bonds have reasonable maturity dates, just in case interest rates explode in the future...which is a distinct possibility.

I will gladly take a solid 10% return and sleep well at night rather than hoping that the economy turns around soon when most of the important evidence that I have seen says it won't. Consumers are in too much debt and housing is still too expensive. The economy will not get better until those simple issues are repaired.

Anyone who earned a 10% annual return over the past two decades would be pretty darn happy right now. I certainly am not completely opposed to buying common stock.  I eventually will begin to do so again when I see some signs that the economy is stabilizing.  If I miss out on a piece of the upside, sobeit.  I now usually buy common stock looking for solid dividends rather than capital gains anyhow, but that's a story for another time.

Deej 

18 Comments – Post Your Own

#1) On February 26, 2009 at 1:40 PM, TMFDeej (99.43) wrote:

Wow, talk about one fast search engine.  I just ran a Google News search for recent articles on Bill Gross and the very piece that I just wrote above showed up fourth on the list barely five minutes after I wrote it.  Amazing.

Deej

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#2) On February 26, 2009 at 1:44 PM, DemonDoug (78.88) wrote:

Deej, just to confirm what you said in an earlier post, you buy corporate bonds through Schwab brokerage correct?

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#3) On February 26, 2009 at 1:50 PM, SharpSEO (70.97) wrote:

Great piece, thanks. I'm surprised he's so openly bearish on stocks.

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#4) On February 26, 2009 at 1:59 PM, SteveTheInvestor (< 20) wrote:

To expand on DemonDoug's question:

Where might I learn more about bonds and what is necessary to buy them?  I've got a basic Roth brokerage account but don't have a clue when it comes to buying bonds.  I've pretty much lost interest in stocks for the foreseeable future and realistically don't have much faith in bonds either, but I guess bonds are better than stocks.  

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#5) On February 26, 2009 at 2:05 PM, SharpSEO (70.97) wrote:

From what I understand, you need a very large portfolio to get enough diversification buying individual bonds.

PIMCO's Total Return fund (PTTAX) is another way to do it.

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#6) On February 26, 2009 at 2:19 PM, IBDvalueinvestin (99.66) wrote:

Short All banks.

Stocks are not dead, you can still short them.

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#7) On February 26, 2009 at 2:24 PM, JakilaTheHun (99.93) wrote:

Good piece as always, Deej.

I actually disagree with Gross's view.  It's a deflationary view, more or less, and I don't see deflation continuing beyond 2010 when you consider how much money we have thrown at this crisis and how many commodities are becoming more scarce and costly to extract --- particularly oil. 

For this reason, you could say that I'm "bullish" on stocks, but bearish on the long-term health of the American economy.  I'd rather buy commodities, stocks of international companies in growth markets, stocks of American companies that will benefit from greater demand for their products in Asia than I would bonds.  I don't view bonds as a safety vehicle any more.  Hard assets are the best safety vehicle.

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#8) On February 26, 2009 at 2:27 PM, RonChapmanJr (89.98) wrote:

I plan on living another 50 years.  Hopefully they won't be dead that long. 

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#9) On February 26, 2009 at 2:55 PM, SideShowMel0329 (41.92) wrote:

You Ultra-Bears always make me snicker.

Just like the ultra-levereged funds, you always lose in the end.

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#10) On February 26, 2009 at 3:00 PM, OleDrippy (34.85) wrote:

I would buy bonds and preferreds through an ETF or mutual fund. Buying individual issues can be pretty capital intensive and a pain, depending on what and through whom you are buying. Probably best to buy a PFF, BND, TIP, or something of that ilk and call it a day. JMHO

Also can look at some country exposure that is not as "encumbered" as the US. I bought some EWS the other week. Singapore still holds claim to being a strong laissez faire economy and EWS has a handsome yield at around 7%.. DYD

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#11) On February 26, 2009 at 3:18 PM, BGriffinFlorida (26.42) wrote:

you can often buy into portfolios of bonds and prefered stocks at significant discounts (20% discount is not uncommon) via closed end funds.

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#12) On February 26, 2009 at 3:39 PM, BigFatBEAR (29.14) wrote:

Deej,

Rec'd - good post.

I'm long-term bullish - "the fundamentals of our economy are strong". Unless a quarter of our population, infrastructure, or knowledge somehow vanish, I think the world will continue to be an exciting, booming place to live over the next 50 years.

That said, your arguments for preferred and bonds interest me. Where can I get my hands on some of the good stuff?? Hook a brother up.

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#13) On February 26, 2009 at 5:05 PM, abitare (31.66) wrote:

Good post, I hate that scum bag Bill Gross. But I am aligned to the thinking that equities are dead money for a decade at least.

FYI- 

Bill Gross Wants Treasury To Buy Assets To Prevent Tsunami

Bond king Bill Gross is back preaching socialism today, stating

U.S. Must Buy Assets to Prevent Tsunami.

 

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#14) On February 26, 2009 at 8:19 PM, TMFDeej (99.43) wrote:

Thanks for reading everyone.  Doug you are correct, I purchase my bonds through Schwab.  I don't think that it is the best broker in the world, but it is a major brokerage that is not in danger of blowing up (as far as I know, he, he) so does the trick and I don't feel like switching. 

One good thing about Schwab is that a few years ago it made its pricing on bonds much more transparent.  It used to scalp investors with huge fees that it did not even bother to break out.  Now everything is very transparent and bond commissions are around $10.

I suppose that it depends upon what your definition of a "large" portfolio is, but one certainly doesn't have to be a millionaire to buy individual bonds in their investment account.  You can buy most corporate bonds in $1,000 increments.  Of course, the smaller the increment you buy in, the higher the commission is on a percentage basis.  Still, a $10 commission on a $1,000 investment is only 1%, which is nothing if you hold on to the bond for a number of years.

As far as what bonds are good buys, use the same criteria as you would use to determine whether a stock was a good buy...but you have a bigger margin of error because if you hold them to maturity the companies that you purchase bonds of don't have to grow significantly to be a successful investment...they just have to just survive. 

If you get their bonds cheap enough even their implosion won't wipe you out because you are at the top of the capital ladder  You could think that a company is a complete joke...but if you strongly believe that it will survive another five years and you are buying a two or three year bond it doesn't matter.

I am not familiar with other brokerages, but Schwab has a search engine that enables account holders to query its database of available bond issues.  All you have to do is enter an amount that you want to purchase, i.e. $1,000, $10,000, etc... a preferred maturity date, and a preferred credit rating from Moody's or S&P (which we all know is a joke anyhow) and pow the available issues appear.  One can then sort them by "YTM" aka yield-to-maturity to see what sort  of rate of return you are getting on your money.

Abitare, your're right.  While I wouldn't put it quite as strongly as you did, Gross does come across as being slightly shady and I usually have pretty decent instinct comes to people.  Having said this, not only is he a smart investor but the tremendous size of PIMCO and its involvement with the government gives him atremendous amount of influence that he openly telegraphs on a regular basis.

Unless we are headed for a period of hyper-inflation, which is possible but certainly not guaranteed I'm very content with the 5% to 10% yields that I have in my portfolio.  Any of the lower return bonds that I have are scheduled to mature in a couple of years anyhow so I won't be missing out on much.  I refuse to lock myself into a long-term, low interest rate bonds...regardless of how solid a company it was issued by.  That is why I have refused to purchase Treasuries for a long time now.  Uncle Sam will pay you back, but he's not giving a reasonable rate of return.  I'd rather literally stick my money under my matress than watch Washington waste it and pay me 1%.

Deej

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#15) On February 26, 2009 at 8:22 PM, russiangambit (29.16) wrote:

It takes a very long time to fundamentally change people's core beliefs and expectations. If the stocks will continue going down for the next 5 years, then yes, they are dead. Otherwise, no.

Bonds are safer than stocks and pay coupons. However, bonds loose value as interest rates rise. How long do you think the interest rates are going to be at 0%?

I am staying away from bonds because bonds are actually not that simple. There is more to them than meets the eye. And I try not to invest in something I don't understand . It always ends badly for me.

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#16) On February 27, 2009 at 12:03 AM, uclayoda87 (29.18) wrote:

I generally agree with russiangambit, although what used to take 5 years to change expectations may now be decreased to 1 to 2 years, especially since the market is 50% off its high from 2007.

I believe that 2011 will be the make or break year for the economy and the US.

I don't understand bonds well enough to feel comfortable investing in this asset class, especially with my expectation that interest rates will eventually rise as the adverse effects of the financial stimuli take place.

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#17) On March 01, 2009 at 3:34 PM, valueandprice (79.66) wrote:

I'm curious, but how come this post doesn's show up in the "Newest Blog Post" list?

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#18) On March 04, 2009 at 8:26 PM, SteveTheInvestor (< 20) wrote:

Thanks to all for your comments on bonds.  Kind of sounds like it's not really for me unless I first devote some serious time to studying the ins and outs.  I'll just stay in cash for now. 

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