Wednesday, February 7, 2007

Investment Bonds are not attractive right now

Recently I wrote an article analyzing the case for bonds and promised to go find some good bonds to invest in. Here at the Finance Wonk I have taken the solemn oath that I would rather be embarrassed and admit to a mistake rather than continue with a bad conclusion. (It helps that I have maintained my anonymity).

Well, I have to tell you that I do not have bond recommendations for you. Quite to the contrary, the bond market is in a place I have never seen it before. It is almost impossible to get paid enough for investing in corporate debt these days.

Now, we here at the Finance Wonk are very well positioned for bond analysis. Using the Altman Z-Score allows one to typically analyze a companies financial solidity several years ahead of the ratings companies, for example (sounds complex but it's all in Bond Investing Strategies and Tips section). Put that together with lots of market access and friends and some interesting observations start to appear.

In my call for buying bonds I noted 5 potential market paths and the effects on bonds. Economic developments have made an inflation scenario more probably, which would be the worst outcome for bonds.

But the biggest issue is that cash is paying much better than it used to compared to bonds! Right now my brokers is paying me a bit over 5% on my cash. US government 2 and 10 year bonds are both below 5% and would drop if inflation hits. Investment grade bonds are yielding about 5.5% and high yield (a.k.a. junk bonds) are around 5.75 to barely into 6% for extreme risks. Think about that for a second, the risk premium you get for high risk is about 1% over the rate on cash! I was able to use Z-score and other analysis to find a couple companies that were yielding above their peers because they are stronger than most people seem to think, but it really doesn't matter. Fundamentally, even if you knew the companies would never fail a payment, the rate offered over a good cash account just isn't enough for the interest rate risk. I'd rather make 5.1% on a cash account and not have to worry about capital declines.

To place your safety bet these days I would actually recommend cash in a good 5%+ brokerage account. This marks the first time I have recommended cash.

Also I would like to point out that as I was composing this story the Wall Street Journal Beat me to it, posting a similar conclusion in an article called "Bond Boom's Thin Ice" (subscription may be required). Respect to them (especially after last year when they published an almost exact duplicate of one of my articles a month later). Seriously though, I love the WSJ guys and I know at least one of them reads my blog because he needled me when I dropped one of their quotes in here without citing it properly on a lazy day. Love ya!

[Personally I think my article gives more concrete advice, but that's probably just a style difference]

Invest Well,

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