The Treasury recently sold inflation-resistant bonds (“TIPS”) at $1,050 for $1,000 face value. With the five-year regular bond yielding only 1.3%, there is a theoretical basis for inflation that might rationalize paying a premium for these “TIPS” but their buyers seem to be driven more by fear than logic. Tolstoy commented “the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him.”
Many investors have firmly persuaded themselves that their best investment course is to buy bonds, regardless of their historically low yields. This is probably a symptom of excessive risk aversion, possibly driven by ego demands to avoid ever admitting to a loss. These emotions seemed to peak during the financial panic in 2007 when the Treasury was selling plain vanilla T-bills without inflation sweeteners at negative yields but the collective memory of that troubled period still makes investors shy away from better decent risks/reward ratios.
U.S. Treasury issues enjoy a premium as “risk-free” but even some corporate bonds are sought after while their corresponding stocks are passed up. Wal-Mart just sold $5 billion of bonds including $1.25 billion of five-year bonds that yield 1.5%. Its stock (WMT-$55) yields 2.2% and it has raised its dividend annually for 36 years.
Granted, WMT stock hasn’t done anything for the last 10 years but that flat line is due to an overvaluation of its earnings a decade ago. It is now trading at 13 times earnings and the return to stock investors will almost certainly exceed that to those buying its new bonds. (I think investors will do even better with faster growing Costco (COST-$63).
A final example comes from that famous defender of the interests of the average investor, Goldman Sachs. It just sold 50-year bonds to retail investors at a yield of 6.125%. Whenever inflation returns with higher interest rates, that won’t be a problem-for Goldman. If rates go even lower, Goldman can buy the bonds back after five years.
I have no objection to bonds in principle (provided proper protection is paid to our principal) but want my clients to be adequately compensated. The closed-end funds that I have been recommending have average maturities of around seven years and credit quality of “BB” to “BBB”. These credit ratings are not Tiffany grade but would be Wal-Mart or Costco if these companies sold bonds. They have moved up in price since first mentioned but I am still buying Western Asset Global Corporate (GDO-$19), at a 6% discount from asset value and a yield of 8.2%.
These funds are not the subject of popular finance programs, generally a good thing. Gold, for example, is much talked about, a possible sign of a top. Investors can keep 10% of their portfolios in top grade mining stocks like Barrick Gold (ABX-$48) and Goldcorp (GG-$45), but should keep their focus on industrial and technology stocks that are showing superior earnings growth.
These include DuPont (DD-$47), IBM (IBM-$144), IFF (IFF-$50), Norfolk Southern ($63) and Pfizer (PFE-$18). All have rising earnings and yield 2% or more. Their prices, which have done nicely for us, backed off a bit on cautious forecasts for the coming quarters. These forecasts are not surprising and these stocks remain buys.
I’ve had inquiries about Baidu (BIDU-$111), the Chinese search engine company. It’s growing very rapidly but the profits of Google (GOOG-$620) are eight times the sales of Baidu and its valuation much more reasonable. Baidu does have a captive market; so does a prison newspaper.
For interesting insights into Wall Street, I recommend Michael Lewis’s The Big Short, from which I took the Tolstoy quote at the beginning of this column. He also wrote The Blind Side, which was about football, but could have been the title for a book about those who thoughtlessly plunge into overly popularized investments.