Scorecard & Bonds Part 1

SCORECARD

We have made it through July and the dog days of summer are upon us. Time to see how my advice has done so far this year, so here goes.

#1) Buy Short Term Bonds and Avoid Long Term Bonds: My favorite Short Term Bond Fund = +15.27%, my favorite Long Term Bond Fund = -20.43%. Answer is correct

#2) Buy Mutual Funds that invest in Stocks rather than Gold: My favorite Stock Fund = +34.49%, my favorite Gold Fund = +14.98%. Answer is correct while gold has done better than I had anticipated and I still do not like gold

#3) Better than anticipated corporate earnings will provide support for the US Stock Market: During July, the US Stock Market indexes reached the high for this year and the return during July was the best since July 1998.

Bottom Line: The Business Cycle Investing Strategy is working well.

BONDS PART 1 (FOUNDATION)

If the idea of investing in the Stock Market gives you a headache and you are not happy with the interest rate at the bank what should you do? The answer is to invest in bonds, where you get interest paid for lending your money. The next few newsletters will be devoted to understanding bonds.

Point #1 = The market interest rate of any bond is moved by the US Treasury Yield Curve.

The reason is that the US government continues to auction bonds in time durations from 30 days to 30 years and since this is the most prevalent source of money it sets the interest rate. As you look at this yield curve, the normal shape is to have a higher rate with longer time. Let me explain further. You can purchase US Treasury bonds with time durations including 1 month, 2 months, 3 months, 6 months, 1 year, 2 years, 5 years, 10 years, and 30 years. A normal investor will only buy a longer time duration bond, such as a 30 year bond, if it has a larger return than a shorter term bond, such as a 1 year bond, because of the risk of holding the investment for the longer amount of time. A point of clarification, a short term US Treasury debt is actually called a Treasury Bill while a longer term bond is called a Treasury Bond. This means that normally it means that a better interest rate is obtained by buying longer time duration bonds. The rate for a short term CD rate will typically be close to the inflation rate and be below the interest rate for the same time duration US Treasury bond. To get a higher rate, typically a longer time duration bond needs to be bought.

Point #2 = When the US Treasury Yield Curve changes shape from being normal to flat or inverted it is time to make investment changes

The reason is that when the interest rate on a shorter term bond is the same or higher than a longer term bond it typically means that the economy has reached a top and will be shrinking. Business Cycle Investing says you want to make significant changes.

Point #3 = Bonds are bought and sold in a Secondary Market and you can get a capital gain or loss.

Traders trade everything, including bonds, and many investors buy and sell bonds before reaching the maturity date for a whole host of reasons. Because of this, the face value of a bond can go up or down giving an investor a capital gain or loss. When you sell a bond, the amount of money you make is the difference between your selling price and your purchase price plus any payments, also known as the coupon payment, you received. If you buy a bond and hold it for the entire time duration you get your coupon payments and your money, face value, back. Essentially, you get what you agreed to. When you sell before the entire time duration, you are not guaranteed to get back you face value it could be more or less. An investor will watch interest rates and when an opportunity arises for a capital gain on many occasions will take advantage of it and sell. By the way, Warren Buffet is a master at this and has made lots of money doing this.

Point #4 = Bonds are issued by all types of entities because of the need for money to fund operationsThe reason is that any enterprise has a need for money to operate goes out of business when it runs out of money. This is why the Chief Financial Officer, CFO, or Treasury Secretary makes lots of money because of the risk involved to the business.