Running Scared

Back in 2001 & 2002, we were in a mild recession but he bond market was treating every company as if they were going out of business.  Bond investors were bailing out of corporate bonds and jumping into treasuries (sounds familiar).  This pushed interest rates on treasuries way down and made corporate bond yields (interest you receive) go way up.  The difference between these two types of bonds is something we monitor closely.  As you can see from the chart, we’re getting back to levels we saw in 2002.  The spread is widening as investors are bailing out of any bond that isn’t a government treasury bond. 

This is creating an opportunity that we rarely see.  The next job is to figure out if this spread has peaked.  I don’t think it has as the economy will continue to weaken for the next quarter (at least).  But, when the economy begins to stabilize and stocks and bonds have potentially sold off more, corporate convertible bonds will be a great investment.  I bought over 20 of these in 2002 & 2003 only to see those prices rise dramatically over the next 12-18 months as the economy and the underlying stocks recovered.

At some point, this economy will recover and so will the stocks.  Our job is to be in position to take advantage of it.  The market is in the middle of adjusting for risk.  As all markets do, they will go overboard.  They will price good assets as extremely risky and safe investments too safe.  What we’re looking for is great companies with great bonds selling at ridiculously cheap prices because the market is throwing the baby out with the bath water.  We’re getting real close.

Flight to Quality 3 5 08


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