Meet Investor 007. His specialty? Bonds. Fixed-income bonds.
Don't be fooled by their low-profile reputation. Beneath that cunning disguise, bonds are sophisticated tools to help safeguard your portfolio from the perils of riskier investments. Here's the latest intelligence on their high-stakes world. If you're new to the game, get briefed on the basics of Investor 007's business, or check out our Bond Center for some useful gadgets to help ensure a successful investing mission.
Spying on rates
The benchmark U.S. Treasuries are key rates to keep under surveillance. Corporate issues are generally priced at a spread to a Treasury rate with a similar term, based on the issuer's credit rating.
|
U.S. Treasury |
Price ($) |
Yield (%) |
|---|---|---|
|
Two-year |
99.21 |
4.93 |
|
Five-year |
99.10 |
4.78 |
|
10-year |
98.25 |
4.78 |
|
30-year |
94.12 |
4.86 |
Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Last week, bonds slipped a bit, as economic data from various fronts came in strong, further pushing back any likelihood of an interest rate cut. For the week, the benchmark 10-year yield increased one basis point, while the more sensitive two-year note yield gained four basis points. Bond prices move inversely to yields.
Financial markets were closed on Monday in observance of Martin Luther King Day. After reopening on Tuesday, bonds edged up for the first time in six days on the news of weak New York manufacturing growth and Asian central bank buying. The yield on the 10-year note fell two basis points to 4.75%.
On Wednesday, Treasuries reversed course on reports of stronger-than-expected December producer prices, industrial output, and increased homebuilder confidence. The two-year yield climbed four basis points to 4.89%, and the 10-year yield rose three basis points to yield 4.78%. The 10-year reached a three-month high of 4.82% on Thursday, thanks to a strong mid-Atlantic manufacturing report and signs of retail inflation in the Consumer Price Index, before buyers seeking yield and technical factors brought the yield down to 4.75%. On Friday, the 10-year tacked on another three basis points in yield, as Treasuries fell because of the highest consumer confidence reading in three months.
Detecting developments
Investor 007 noted the following occurrences in the bond market last week:
- Former junk-bond king Michael Milken spoke at a London investors' conference about his view that development of an asset-backed credit market could help developing countries raise as much as $100 trillion.
-
Standard & Poor's, a division of McGraw-Hill, announced that the global default rate for junk bonds dropped to 1.09% in December, close to September's record low of 0.94%.
- According to an SEC filing by Realogy (NYSE:H), the company intends to sell $3.65 billion high-yield bonds. Apollo Management is also seeking $8.98 billion of additional debt financing in connection with the real estate service provider's leveraged buyout.
Hot tip
Many of us make resolutions about our eating choices at the start of the year. Why not do so with our portfolio selections, too?
This year, it's expected that investors will be able to pig out on corporate debt once again. Last year's strong earnings growth facilitated strong cash positions and near-record-low default rates, which led to a historically tight credit spread between Treasuries and corporates. According to the Securities Industry and Financial Markets Association forecast, these conditions are likely to continue into 2007, with corporate bond issuance poised to continue near last year's high levels.
This is good news for the issuer, but is it good fare for the investor? Obviously, investors will have a choice of bond issues to consider, although those won't sport sweetened coupons.
Other factors exist, as well. Intraday volatility in the Treasury market increases during periods of heavy corporate issuance. Companies often sell Treasuries prior to their own debt sale, in order to protect against a rise in Treasury yields which would make their borrowing costs more expensive. If yields do rise, the Treasuries can be bought back at a lower price, thereby offsetting their increased borrowing costs.
Investors have also enjoyed an environment of apparent safety, but shouldn't relinquish awareness of credit risk. Some issuers will try to take additional advantage of the friendly environment. One such example is Aramark (NYSE:RMK), a food provider for sports arenas, cafeterias, and convenience stores, which is having a field day at present. The company's debt financing in connection with its leveraged buyout is void of many typical restrictive covenants, yet it's attracting significant investor interest. And Aramark's not the only one. According to Standard & Poor's, roughly 10 times the amount of so-called "covenant-lite" loans were made last year than in 2005, totaling $24.1 billion.
As the year gets underway, knowing your risk appetite and yield goal should help you enjoy a feast from the anticipated corporate-bond smorgasbord, without any nasty stomachaches.
Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since serving in banking and legal capacities covering debt underwriting as well as fixed-income derivatives. She owns U.S. Treasuries and shares of the Fidelity Inflation Protected Bond Fund. She prefers her portfolio shaken, not stirred. The Fool has a disclosure policy.
