“Caution: Never get into a fight
with a man who buys ink by the barrel”

Bertrand Russell

July 21, 2003

We were astounded when we saw the following poll results:

“Bethesda, Md. – June 26 – A survey conducted by Harris Interactive on behalf of ProFund Advisors LLC finds that, although most U. S. investors (57%) believe interest rates will rise in the next two years, nearly two-thirds (65%) are unaware that rising rates generally have a negative impact on the value of bond investments.”



“GM bonds tap into ‘wall of money'” according to the June 27th Financial Times which then reports “Car giant benefits from buying frenzy as cash-rich investors ignore shares and scramble to buy bonds in search of higher returns.”

On June 26th GM sold $17 Billion of bonds – the largest amount of bonds ever sold in the corporate debt markets. The purpose, in large part, was to offset about $20 billion of GM’s unfunded pension liabilities.

Later from the FT article: “Disillusionment with slumping stock markets has caused investors to migrate in droves toward the bond market, with the result that fund managers have mounting piles of cash waiting to be invested but not enough new bond issues to absorb it. And the dramatic decline in interest rates is making investors increasingly desperate for yield.”

Total orders for the GM and GMAC, its financing arm, amounted to $30 billion with European demand strongest in the 30-year bonds. The bonds apparently appeared to be extraordinarily attractive investments because of their yield. The GM 10 year bonds were priced to yield 7.22% — 3.75% over US Treasury bonds having the same life. The 30-year bonds were priced to yield 8.5%, about 4% higher than the Treasury having the same maturity.

In March 2000 stocks never looked better than when they were at their all time highs. We were on record long before then and subsequently as having warned many times about the incredible stock bubble. Please see “Commentaries” on our Web site

Our economy still has not picked up satisfactorily since the attacks of September 11th. Interest rates, largely as a result of the Federal Reserve’s efforts to stimulate the economy, are now at 45-year lows as the US base interest rate is 1%. Bank deposit rates are 0.5% and taxable money market funds yielded 0.64% on June 24th, an all time low according to iMoneyNet.

It is interesting to note that Elizabeth Krauss, a managing director at State Street Research & Management, recently said “we stand by our commitment to shareholders” a promise by State Street Research that will keep the (money) fund’s yield at no less than 0.10%. (WSJ – June 26)

On Friday, June 13th, the 5-year Treasury note closed at 2.029% – almost 2% – its lowest level since January 1955. The 10-year closed at 3.10% – almost 3% – its lowest level since July 1956. And the 30-year Treasury bond closed at 4.17% – close to 4%.

These yields were, as mentioned, on June 13th, eight business days before the GM sale on June 26th.

As of this writing the 5-year Treasury yields 3%, the 10-year at 4.14% and the 30-year at 5.04%. These moves from June 13th to July 21st are highly noteworthy at the very least. We cannot calculate the billions lost in bonds in this very short period and speculate about the 65% of Americans in the June 26th Harris Interactive survey mentioned at the very beginning who are “unaware that rising rates generally have a negative impact on the value of bond investments.”

The long and short of it is that we could very significantly increase the nominal yield on portfolios if we:

– Bought bonds having longer maturities, and
– Bought bonds having a lower credit rating.

Example: GM bonds having a maturity of 30 years, a marginally higher rating than “junk” (BBB) and a yield to maturity of 8.5% on June 26, 2003.

We note that the largest demand for the GM bonds was for those that had a maturity of 30 years, the longest maturity offered.

Also note that the feeding frenzy for GM’s bonds was by investors who obviously were/are no longer risk averse as General Motors is rated BBB — only two notches above the rating for junk bonds.

GM bonds were sold to buyers who were in a frenzy to buy bonds 1) having a long life 2) having a much lower than “investment grade” rating at a time when the bond markets were at or close to all time highs.

Aside from professional traders, many of the GM/GMAC bond buyers have chosen to disregard the bonds’ inherent risk or don’t care about taking large risk in their frenzy for higher yields. It is possible that some simply do not understand the risk they are taking when bond prices were at 45-year highs. Just like the buyers of stocks at their all time highs in the March 2000 era.

We have not and will not do that to our clients.

We have been increasing the percentage of stocks in clients’ portfolios in recent months. However, several not insignificant problems continue to be the facts that

1. The economy still has not shown the beginning of credible recovery in many areas that would lead to increases in companies’ earnings necessary to support a sustainable higher stock market; and

2. Many of the stocks we want to buy are still not attractive buys in terms of their market price vis-a-vis their fundamental value. In other words, they are not cheap.

Some traders call this an ABC market. Anything But Cash.

The general tone of the stock markets has been improving, and we hope it will continue although the casino mentality is beginning to surface once again as hot money drives up small company shares. While being pleased with the recent improvements in the markets, we are using caution as our foremost objective continues to be Preservation of Capital.

Keep in mind the fact that Alan Greenspan and his colleagues at the Fed have not continued to lower interest rates because they see signs of Economic Irrational Exuberance.

The must-win bet is on a U. S. economic recovery.

Meanwhile, cash is indeed trying to be Anything But Cash.

John W. Hamilton
July 21, 2003