Today, the frothiest sector of the fixed-income market is high-yield (aka "junk") bonds.
The average price for junk bonds is the highest since 2004... And average yields (which fall as prices rise) dropped below 6% for the first time in history, according to Barclays.
The Barclays High Yield Index returned 15% last year... And junk bonds are up nearly three-quarters of a percentage point this year (while most other types of bonds have lost value – meaning yields have increased).
At 6% yields, junk bonds still pay much more than Treasurys (which yield around 1.85% today). But the market is getting crazy...
Remember, when buy a bond, you're loaning a company money. It agrees to pay you a fixed rate of interest over a set period of time… At the end of that time, you're paid back the par or "face value" of the bond. Most bonds have a face value of $100. So when it matures, bond holders at the time receive $100.
Since these are the riskiest corporate credits... They normally trade at discounts to their face value. But right now… the average price for junk bonds is 5% above par. So anyone paying $105 for a bond today is accepting a $5 capital-gain loss, if he holds to maturity.
Usually, the best time to buy junk bonds is when they're trading at large discounts (giving you a healthy margin of safety in case of default)... Not at premiums.
And consider this… many bonds have "call" provisions that allow the company to retire the bond early… by buying them back from investors at set price
And 45% of junk bonds currently trade above the level at which companies can "call" their bonds back. So again, if you buy a bond at $105 that the company can buy back at $104, you're accepting a likely loss on your principal...
As you can imagine, companies are scrambling to issue new debt to take advantage of record-low interest rates. And they're retiring old bonds with that money. Companies repurchased $101 billion of bonds in 2012, a 16-year high and 38% increase over 2011, according to JPMorgan.
In addition to the risk of overpaying for risky assets, there's a larger issue at hand for junk-bond investors... Inflation.
Digest readers know we expect global central banks' money printing will lead to a massive inflation. As yields rise, bondholders (especially those holding the riskiest bonds) get killed.
Even the largest bond investor in the world, PIMCO's Bill Gross, is advising investors to be careful with bonds... He's even telling folks to buy gold. Remember, he makes his fortune when people buy bonds, not sell them.
We've made great money in high-yield bonds... Steve Sjuggerud recommended Guggenheim BulletShares 2015 High Yield Corporate Bond Fund (BSJF) in February 2012. His readers are up 8% since then.
And we're not saying you should exit your position... If you're long and collecting a strong income stream, stay long. But now is not the time to initiate a new position.
Avoid these popular bonds…
In today's Digest Premium… we take a look at one investment vehicle investors are clamoring to buy… and the risks they're taking on...
To subscribe to Digest Premium and access today's analysis, click here.
Real estate: 'Get on it!'... Blackstone is doubling down on real estate... It's cheaper to own than rent... Jeff Clark's 400%-potential pharma trade... Howard Marks on investor sentiment... The frothiest bonds... Where to hide your gold...
Steve Sjuggerud is still bullish in residential real estate.
He has been urging subscribers to invest in the opportunity since early 2011... Prices were down, mortgage rates were low, and sentiment was in an uptrend. Today, prices are still low (albeit rising), and mortgage rates are even lower than they were. Plus, sentiment is recovering. In short, there's still opportunity.
In the January issue of True Wealth, Steve wrote:
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We really have the perfect set-up in
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Orlando, Florida is a perfect example... My brother forwarded me an article from the Orlando Sentinel newspaper this week...
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"Orlando Home Prices at Three-Year High," the headline says. But what is "high"?
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The median home price in Orlando, Florida is just $129,000. Even better, that is up 12% from a year earlier! So our uptrend is clearly in place.
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The market is poised to soar... housing "supply" in Orlando is down to just three months. This number is incredibly low. When the supply of houses is high, prices fall. And when the supply is low, prices rise. Consider this: Nationwide, we've never had a three-month supply – in four decades of data.
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It is the perfect set-up – stupidly low home prices and mortgage rates, no supply, and our uptrend is in place.
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If you are not in residential real estate yet... get on it!
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And Steve's not the only investor taking advantage of the setup in real estate... Private-equity behemoth Blackstone, the largest U.S. private real-estate owner, is also betting big on single-family homes. According to the Bloomberg Financial news service...
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Blackstone has spent more than $2.5 billion on 16,000 homes to manage as rentals, deploying capital from the $13.3 billion fund it raised last year, said Jonathan Gray, global head of real estate for the world's largest private equity firm. That's up from $1 billion of homes owned in October, when Blackstone Chairman Stephen Schwarzman said the company was spending $100 million a week on houses.
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"The market is moving much faster than anybody thought possible," Gray told Bloomberg. "Housing is much stronger than people anticipated."
The company is buying short sales and foreclosures, fixing them up, and renting them out.
According to Gray, the company has bought homes so quickly that it's "warehousing" more than half its portfolio as it completes the purchases and hires staff to renovate and rent the properties. Gray said it takes around 30 days to renovate each home and up to 30 days to lease it... "Renovating the 16,000 homes is an enormous job," Gray said.
Blackstone is focusing its purchases in nine areas (Phoenix, Chicago, Atlanta, Las Vegas, Miami, Orlando, Tampa, and northern and southern California) where prices were "overshot." Prices in those cities are now up an average 22% in the past 12 months through October.
Blackstone got a $600 million line of credit from German banking giant Deutsche Bank last October. And it's currently in talks to double the amount... It's still buying heavily.
Steve has loaded the True Wealth portfolio with stocks to take advantage of the rebound in housing... His readers are up 69% on the iShares Home Construction Fund (ITB), which just hit a new 52-week high yesterday.
To learn more about a subscription to True Wealth – and what Steve is recommending to profit off a rebound in housing – click here.
Here's a great chart from JPMorgan Asset Management showing the recent dislocation between monthly rents and monthly mortgage payments (the cost of renting versus owning a home).
As you can see, as of the most recent data available, owning a home is 33% cheaper than renting. (The mortgage payment assumes a 20% down payment and a 30-year fixed mortgage.) Why the discrepancy? Most folks don't have money for a down payment... or they can't get financing. But this discrepancy only makes owning and renting a home even more attractive...
Jeff Clark is starting the New Year with a huge upside potential trade for his S&A Short Report subscribers...
He just recommended a trade on a pharmaceutical stock that will have an FDA hearing on a new drug this month... And if this company gets the "green light," shares will soar.
Speculating on the outcome of an FDA ruling is risky... If an important drug candidate fails to win approval, its future is thrown in limbo – and investors hate uncertainty. But in this case, Jeff says the stock has strong earnings (growing at 20% a year), it's cheap, it has loads of cash, and no debt... And if its drug gains approval, the stock will reward traders.
The market is excited about the release of its new drug... And assuming the FDA approves the drug, Jeff says readers can make in the neighborhood of 300%-400% on this trade over the next month. Remember, this trade is a speculation. You can learn more about the S&A Short Report and how to gain access to Jeff's latest trade by clicking here.
Billionaire hedge-fund manager Howard Marks recently released a note to investors discussing his outlook on the current market... The 13-page memo was about the cyclicality of markets and the role investor sentiment (not fundamentals) plays in those cycles...
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This memo is devoted to the cycle in attitudes toward risk. Economies rise and fall quite moderately (think about it: a 5% drop in GDP is considered massive). Companies see their profits fluctuate considerably more, because of their operating and financial leverage. But market gyrations make the fluctuations in company profits look mild. Securities prices rise and fall much more than profits, introducing considerable investment risk. Why is that so? Primarily, I think, because of the dramatic ups and downs in investor psychology.
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The economic cycle is constrained in its fluctuations by the existence of long-term contracts and the fact that people will always eat, pay rent, buy gasoline, and engage in many other activities. The quantities involved will rise and fall, but not without limitation. Likewise for most companies: cost reductions can mitigate the impact of sales declines on earnings, and there's often some base level below which sales are unlikely to go. In other words, there are limits on these cycles.
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But there are no checks on the swings of investor psychology. At times investors get crazily bullish and can imagine no limits on prosperity, growth and appreciation. They assume trees will grow to the sky. Nothing's too good to be true. And on other occasions, correspondingly, despondent investors can't think of any limits to how bad things can get. People conclude that the "worst case" scenario they prepared for isn't negative enough. Highly disastrous outcomes are considered plausible, even likely.
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Over the years, I've become convinced that fluctuations in investor attitudes toward risk contribute more to major market movements than anything else. I don't expect this to ever change.
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Currently, Marks says investors aren't optimistic. But they're still putting money to work because they think they must... Retirees and pension funds, who depend on a fixed level of income, are moving out of low-yielding Treasurys and into riskier assets.
So while we're far from the irrational exuberance of 2006-2007, money is flowing into riskier assets (mainly in fixed income).
As Editor in Chief Brian Hunt wrote in yesterday's DailyWealth Market Notes, the market is in "risk on" mode. That means it's time to be careful.
There are still plenty of deals in equities. But the bond market is frothy. In today's Digest Premium, subscribers will learn what we believe is one of the frothiest sectors in fixed income – and one we'd avoid outright.
New 52-week highs (as of 1/8/13): Berkshire Hathaway (BRK), iShares Dow Jones U.S. Home Construction Fund (ITB), Sprott Resources (SCP.TO), Targa Resources (TRGP), Monsanto (MON), 3M (MMM), Alico (ALCO), Becton-Dickinson (BDX), Magellan Midstream Partners (MMP), Walgreens (WAG), and Home Federal Bancorp (HOME).
A light day for the mailbag. Let us know where you hide your gold. Send your notes here... feedback@stansberryresearch.com.
"I need a place to hide [my bullion], any suggestions?" – Paid-up subscriber JBS
Goldsmith comment: As you know, we're big proponents of holding physical gold for a variety of reasons. It's one of the best ways to take control of a portion of your personal wealth. You have a lot of options for storing it. Some of the simplest include putting it in a safe in a discreet part of your home. We know folks who literally bury it in their backyards. (Although if you do this, make sure to note where it is!) Some of our editors, including Porter, have suggested using private self-storage, including overseas. And Dr. David Eifrig suggests moving your gold into a safe deposit box in Canada.
"Absolutely [I've been buying gold]! I've been with Rick Rule since '99 and made an 800% return on my money in metals stocks in 4 years. Rick – and many others – believe that the stocks are even cheaper now (relatively speaking) than they were then.
"The mining industry has always been considered a 'burning match' to the likes of Rick and Doug Casey. But when that match is finally stuck, boy, can it light things up!
"And since it appears we're at a very similar juncture in this cyclical market as in the late '90's, I'm in with 25%-30% of my assets. You just have to be a little bit patient (since, in the words of Rick Rule "inevitable doesn't mean imminent") but the payoff, I believe, will be phenomenal – again.
"Keep up the great work!" – Paid-up subscriber Greg Jones
Regards,
Avoid these popular bonds…
In today's Digest Premium… we take a look at one investment vehicle investors are clamoring to buy… and the risks they're taking on...
To continue reading, scroll down or click here.
Avoid these popular bonds...