Strategies for Low Interest Rates
Advisors Capital Management
Charles Lieberman
October 25, 2010
Investors continue buying bonds, today's hot product, while companies continue to satisfy this frenzy by selling new issues at every opportunity. One side of this trade must be wrong. Since such borrowing is so extraordinarily attractive for companies, investors must be accepting far more risk than they appreciate.
A Bloomberg article on bond buybacks caught my eye. Companies are tendering for their own debt at a premium, so they can replace these short-term maturities with much longer-term new issues. The example used to demonstrate this point is CBS, which offered at 113.1 for its 8-5/8% of August 2012, and issued two new bonds, a 4.3% of February 2021 and a 5.9% 30-year issue. While the company is paying a sizable premium to buy back a bond maturing in less than two years, it is locking up very cheap financing for a long time. What is most noteworthy is they are not alone. According to the article, more than $30 billion in tenders occurred last month! This activity is not materially different from households refinancing their mortgages, except households can refinance without paying a premium to pay off the existing debt. If the case for refinancing debt is so compelling, to the point companies are willing to pay sizable premiums to buy back their bonds, why are households shifting capital from stocks to bonds?
Investors now seek safety, calculated as just getting their capital back. And if they also pick up a little incomeit is very little income these days that's fine. The objective is return of capital, not the return on capital. (We'll see how long this lasts.) In the meantime, the stock market is rallying without them. Despite the litany of issues that anyone can provide on the economy's travails, corporate earnings continue to beat estimates and the equity market's valuation remains cheap. Strategists keep suggesting that earnings projections are overly optimistic. But the companies continue to exceed these estimates and business discussions sound consistently more positive, even as corporate leaders remain cautious as well. No one believes economic conditions will improve, despite the economy's ongoing tepid recovery. I can think of no better reason to have even more conviction that stocks are unreasonably cheap and an extended rally should continue into the future.
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