The Increasingly Fragile Value of BondsJames Cordelaine
Stocks and bonds. The two words are almost always mentioned together – like salt and pepper, or Bogey and Bacall.
Stocks have customarily been sold as the investment for those who can afford and tolerate risk. Bonds, on the other hand, have traditionally been presented to investors as the mainstay of conservatism and safety. Invest in stocks when you’re young, suggests the conventional wisdom. Then, as you grow older, gradually transfer the bulk of your portfolio from stocks to bonds. In the strict application of this formula, a very young person with some money who invests principally in bonds is missing out on fabulous opportunities; whereas a person up in years heavily into stocks is walking a tightrope without a net. Risk is for the young; the “guaranteed” capital preservation of bonds is for seniors so the thinking goes. Let’s look at that.
A bond is actually a loan or an IOU. When you buy a bond, you’re actually lending money to a large borrower like a corporation, or a governmental entity like a city, state or the federal government. The borrower, in turn, agrees to pay back the entire amount you invested by a specified “maturity date,” and also compensate you with periodic interest payments in the form of “coupons.”
While all this might seem familiar stuff, it’s worth mulling over. Because if we value our financial resources, when we read words like “borrower,” “lender” and “IOU,” we’d also be well advised to consider the word “default.” What if the borrower of the money we lend defaults on its obligation? A government defaulting on its obligation? A corporation defaulting on its obligation? Ridiculous, you think?
Think again. According to CBS News MoneyWatch, as of the end of March of this year, corporate defaults had risen to their highest level since 2009. Just in the first two weeks of April, defaults on high-yield bonds amounted to fourteen billion, the highest monthly volume in two years. In fact, the first quarter of this year was the fifth-highest quarterly default total on record at $31.4 billion, according to J.P.Morgan. And, according to Bank of America Merrill Lynch’s High-Yield Strategist, Michael Contopoulos, “[C]umulative losses over the length of the entire [default] cycle could be worse than we’ve ever seen before.”
What’s also disturbing is the big rating agencies – Standard & Poor’s (S&P), Moody’s and Fitch Group are looking at big companies, assessing their ability to pay back their lenders, and lowering their credit ratings accordingly. Due to reduced oil prices, Exxon lost its coveted AAA Standard & Poor’s rating after six decades. There are now only two remaining American companies – Microsoft and Johnson & Johnson – that can boast this rating.
So go with the conventional wisdom, if you like, and think of bonds as being on the conservative side of paper assets. But as a safe haven, physical gold has bonds beat by a country mile. Gold is a tangible asset that, once you pay for it, you own outright. Unlike bonds, gold represents no one’s obligation or IOU. And no rating agency can ever come between you and your shiny metal, or your shiny future.