Howard Marks, the billionaire founder of Oaktree Capital hedge fund, wrote his latest note to investors about the high-yield bond market. As we've discussed before, high-yield (aka "junk") bonds are trading at record-high prices. (Consequently, they sport record-low yields, along with the rest of the bond market. (Average yields are now below 6%.)
But Marks still believes there's value in the high-yield space. As he wrote in his note...
While yields are near all-time lows, yield spreads tell a very different story. Today the average spread on our U.S. high yield bond portfolios – approximately 490 basis points – is toward the high end of the normal historical range we've invested in for nearly three decades.
We believe such an average spread provides more-than-adequate compensation for our default experience, which over the last 27 years has averaged 1.4% per annum. With corporate balance sheets in relatively good shape (thanks in large part to all of the refinancing activity over the past two years), the capital markets awash in liquidity, and economies (at least in the U.S.) showing some strength, default rates are projected to remain below the long-term average for at least the next twelve months.
Even if Oaktree's high-yield portfolio experienced a massive 9% default rate (an unparalleled event), Marks says the bonds would perform on par with Treasurys. Assuming normal conditions, Marks believes high-yield bonds will return around 5% this year. (The average yield is 5.7%.)
Bill Gross, manager of PIMCO, the world's largest bond fund, had a similar view regarding bonds in his latest investment outlook. He revisited former Federal Reserve Chairman Alan Greenspan's theory of "irrational exuberance." He believes we're currently in a period of "rational temperance"...
On a scale of 1-10 measuring asset price 'irrationality,' we are probably at a 6 and moving in an upward direction.
Gross notes investors purchased a record $100 billion-plus of high-yield and levered loan paper last year. And while he's more wary of the high-yield credit markets than Marks is, Gross still believes you can generate a decent return.
Corporate credit and high-yield bonds are somewhat exuberantly and irrationally priced. Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is still fragile. Still, that doesn't mean you should vacate your portfolio of them.
It's possible Marks and Gross are right... and high-yield bonds will provide a reasonable return over the intermediate term. But Steve Sjuggerud is telling his readers, "Don't take the bait." It's not worth the risk.
Here's what he wrote...
I don't expect an IMMEDIATE butt-kicking in high-yield bonds... My general belief is that more and more unsuspecting investors will end up piling into these bonds, pushing prices even higher (and yields even lower). Investors will do this because they're earning no interest at all in the bank, and they're desperate for interest.
You might be desperate for interest, too... But don't take the bait...
I don't want to own them here. The small reward isn't worth the big risk. The yield is too low. And the premium on the bond prices is too high. The yield looks nice... But at this point, high-yield bonds are pigs wearing lipstick.
Lighten your load on high-yield bonds now. I believe that cash in your mattress – earning zero-percent interest – will likely outperform high-yield bonds from now through the next "butt kicking."
An update on yesterday's Digest about rising home prices and falling supply... The latest report from the National Association of Realtors (NAR) – released today – shows that pending home sales soared in January. Contracts to buy existing homes jumped 4.5% in January, above expectations of a 1.8% gain. Volume is currently 9.5% above January 2012... And it's the highest reading since April 2010.
The surge in activity has helped push U.S. home supply to its lowest level in 13 years, according to NAR.
"Favorable affordability conditions and job growth have unleashed a pent-up demand," said NAR Chief Economist Lawrence Yun. "Most areas are drawing down housing inventory, which has shifted the supply/demand balance to sellers in much of the country. It's also why we're experiencing the strongest price growth in more than seven years."
One of Porter's favorite whipping boys, solar company First Solar, opened down 14% today after disappointing earnings...
The company announced a 15% drop in "expected revenue" for 2012. First Solar had $8 billion in expected revenue in 2012, down from $9.4 billion a year earlier, CEO Jim Hughes said on a conference call yesterday. This new metric includes solar panels that will be installed at the company's solar farms and future sales to other developers.
First Solar is trying to spruce up its revenue by making up a metric that includes future revenue... But it's still failing.
"Creative" accounting like this is one of the first signs of trouble for a company. But it's only one of First Solar's many problems – like the fact that its solar panels don't work in the heat. For a full overview of Porter's bearish stance on First Solar, be sure to reread the March 9, 2012 Digest.
All this week, we're proving the power of Steve Sjuggerud's proprietary, computer-based trading service, True Wealth Systems.
Steve has spent years – and more than $1 million – developing the computer system that supports this advisory... In True Wealth Systems, Steve processes decades of financial data to find simple, actionable trading systems across all sectors.
To date, Steve has found more than three dozen of these systems. He's now profitably trading gold, homebuilders, virtual banks, and health care stocks... just to name a few.
But that's not all his computer system can do...
This week, we challenged Steve to cut through the vague claims and theories you hear in the mainstream press... and simply let the numbers do the talking.
On Monday, Steve proved that high economic growth doesn't lead to great stock market returns (it's just the opposite). Yesterday, Steve ran the numbers on the market's overall valuation... and whether stocks are cheap or not today.
As we told you on Monday, in today's world of political flim-flam, baseless Internet claims, and Wall Street double-speak, putting ideas to the test – and letting the numbers speak clearly for themselves – is more important than ever.
And one of the most important questions investors have right now is: Should I sell? With the market reaching new highs, is it dangerous to own stocks? Here's what Steve's numbers say...
We tested which strategy works better: Buying near 52-week lows... or buying at 52-week highs. We looked at nearly 100 years of weekly data on the S&P 500 Index, not counting dividends.
You might be surprised at what we found...
After the stock market hits a 52-week high, the compound annual gain over the next year is 9.6%. That is a phenomenal outperformance over the long-term "buy and hold" return, which was 5.6% a year.
On the flip side, buying when the stock market is at or near new lows leads to terrible performance over the next 12 months... Specifically, buying anytime stocks are within 6% of their 52-week lows leads to compound annual gain of 0%. That's correct, no gain at all 12 months later.
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1950 to 2012
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All periods
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7.2%
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New Highs
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8.5%
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New Lows
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6.0%
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If you're a long-term investor and you're thinking of taking your money off the table, don't. As Steve says, "We're not making this stuff up... We're just asking our True Wealth Systems database for the facts... And these are the facts."
New 52-week highs (as of 2/26/13): Constellation Brands (STZ), PepsiCo (PEP), and Eli Lilly (LLY).
Someone took Steve's advice to buy a rental property... And he's making 9% a year. Have you invested in real estate recently? Let us know at feedback@stansberryresearch.com.
"Common wisdom is that gold is an inflation hedge and will do well in inflationary times, but inflation has been relatively low the past 10 years yet gold has done quite well. What's the correlation between gold and inflation?" – Paid-up subscriber Patty
"Well, I did it. After contemplating buying rental property for fifteen years, I took Steve's advice and just bought a single family home to rent out. My ROR – assuming one month of vacancy per year – should be 9%. This figure excludes any appreciation, which I anticipate. The home is in excellent shape with many upgrades; even the furnace, A/C and water heater have been replaced in the last year. I think I got a little lucky to fully transparent.
"Houses in this area [Colorado] are selling like crazy. It sure helped that a good friend of mine is a successful real estate agent. The first home he showed me, which had only been on the market for two days, was already sold before we put an offer on it. Another home – his listing – was in the process of being renovated. He actually steered me away from it because he thought the layout was weird. But in the first three days after going on the market it had SIX offers!
"While it would have been great to buy a year or so ago, I'm not one to try and catch a falling knife. Thanks Steve, I never would have took the plunge without your strong encouragement. Who knows? Maybe we will end up buying another property if this works out." – Paid-up subscriber Rob T.
Regards,
Sean Goldsmith
New York, New York
February 27, 2013
In yesterday's Digest Premium, we discussed how Michael Dell wants to take the computer company he founded private.