BONDS

“the income from bonds erodes over time and, if you spend all the income from a bond, you consume capital” James Garland, Connolly Report October 1996 from a Forbes magazine column in June 17 1996 issue. Garland does good work. Google him

If you are thinking of buying a bond, you have to read Part VI of Chapter 6 from page 93 in Mr. Market Miscalculates by James Grant. Part 6 is called 'Snoopy Deploys Capital. You won't buy the bond. Believe me!. The book will cost you about $18 and will be worth every cent. If you don't at least read the book in a book store, I hope you buy the bond and lose thousands. Seriously. Grant is convincing Now that you've got Grant's book, read page 76 too. Here Grant compares stocks and bonds. He explains why stocks are safer. Also read pages 266 to 274 about bonds: 'Bonds The Next Generation'. There is more about all this in my February 2009 report.

If you are thinking of buying a bond, you should read Chapter 4 in Just One Thing by Gary Shilling. It´s great and has a lot of charts. The great bond rally began in November of 1981. As I key this on December 23 2008, it´s still on. But the last sentence in Shilling´s chapter is Ònly when the heard stampedes into my corral will I worry that the bond rally of a lifetime is ending`.

In the April 23 2007 issue of Forbes, Richard Lehmann, their fixed income columnist, outlined three reason for holding bonds. Not one of the reasons involved bonds being a good investment. As I don't buy bonds, I loved it! In fact, Lehmann's introductory sentence was: “Over a long enough period stocks always beat bonds”. I loved Lehmann's third sentence too: “Bonds and preferreds, unless they drastically down graded, hover around their par value”.

I never buy bonds because there is no growth of income, and with interest rates so low, there mostly likely will not be growth of capital either. Think inflation. Connect inflation and fixed income. Result: destitute at 80. It's that simple. In the long run, you'll lose far more in bonds than in any stock market correction. As I write this on a ship bound for Kaua'i in April of 2007, BCE bonds are getting hammered because of takeover talk surrounding the company: BCE's common shares, on the other hand, are rising with the excitement.

What are Lehmann's three reasons for buying bonds?

• “Bonds are ballast against bear markets in equities”

• “You may need to raise cash at an inopportune time”

• “the opportunity to rebalance” a portfolio

Connolly Comment: • My ballast is dividends, growing dividends. • My stocks were purchased years ago and are now well above my cost. I can sell 100 shares for emergency spending any time. • Why rebalance when my return on capital with stocks is double digit…and growing. Sell a winner to buy a loser? Hello! They never tell you when to re-balance, do they? They don't know. It's all very theoritical. Re-balancing sounds good: it does not work practically.

Other Comments on Bonds “In the long run, not only do stocks have higher returns than bonds, but also lower risk.” Jeremy Siegel p 292 in Stocks for the Long Run

“Buy bonds in lots of less than $100,000 face value and you'll have limited choices and likely get shafted on bid/ask spreads.” Richard Lehmann, Forbes, Feb 12 2007

“the single justification for Yale's bond portfolio [5 percent of assets] is to hedge the endowment fund against the risk of an extended period of deflation in the economy. Stability of income and principal are subordinate objectives” Capital Ideas Evolving, 2007 p 158

“Bond trading is a notoriously inefficient market, allowing brokers to earn juicy margins for facilitating trades - at least with retail customers.” The Economist Jan 15 2000

The American national debt is something in the order of 9 trillion dollars and growing at over 1 billion dollars a day. How will they finance this debt? Through inflation. And what happens to bond prices in period of inflation? Will your interest payments be worth more or worth less?

“Bonds Don't Preserve Capital. The Money Masters by John Train, p 219 in Chapter 11 Conclusions, 1980 Harper & Row “A final bad deal for the investor, generally, is bonds, unless he reinvests the income. The notion that they are 'conservative' is grotesquely unrealistic.”

“after studying the experts in long-term asset class returns, such as Ibbotson from Yale, we came to the conclusion that's its [bonds] not a very good investment” Lowell Miller, January 27 2007

If you buy bonds, you are lending money to somebody so the whole system is geared to you getting back in real purchasing power, less than you lent. Lowell Miller

“As for ordinary fixed income investments, they [Walter and Edwin Schloss] steer clear.” Value Investing from Graham to Buffet and Beyond, page 266 by Greenwald et al 1999

Money represents purchasing power. An investment that just breaks even over time returns only a fraction of purchasing power, after inflation. At only 3.5% inflation over the course of a decade, that which costs $1 will cost $1.41. If your own bonds, one third of their value will disappear in 14 years with inflation at only 3%: think destitute at 80.

“Do you need bonds? Was the title of a column in summer 2007 issue of MoneySense. They reached an interesting conclusion. This idea, from Stephen Jarislowsky, was included in the article: “if you plan to hold a large sum of money outside of an RRSP for a long period of time, you may indeed want to ditch the bonds and go 100% stocks”.

Franz Pick called bonds “certificates of guaranteed expropriation”. “After tax, bonds generally yield less than the inflation rate. The present half-life of money is eight to ten years; so, if you spend the income, only half your buying power will remain after eight to ten years in real terms, and only one-quarter after sixteen to twenty years. You'll have run through your capital without even realizing it.” The Money Masters p 219

If you are just starting to invest in dividend growth stocks and you also hold bonds, I'd keep them for a while…until the dividend income starts to grow…until you realize what's going on. Once your 'yield on cost' gets close to the yield on your bonds, you'll know what to do.

If you are really worried about stock prices falling, sell enough of your stocks to get your money back. You've then 'bondified' your portfolio and you can't lose. I used to do this, but don't any more.

Financial Post, January 1931: “As the markets become more settled your client might sell her Dominion of Canada bonds and re-invest in the best common stocks. The stocks mentioned here are sound investments. Dominion Bank, Imperial Bank, Bell Telephone and Canadian Pacific Railway. Keep your Gatineau bonds and your Montreal Light Heat and Power bonds.” Connolly Report, December 1997, page 399 (TC: As a matter of interest, the market bottomed in 1932.

“Treasurys [bonds] are no more inherently safe than stocks are inherently value-laden. Safety and value are qualities conferred not by the nature of an asset but by the price at which it is acquired” (James Grant, Forbes Oct 28 2002.) Connolly Report

• “In general, the bond…markets are volatile. Fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.” from a Fidelity ad in The Economist of December 4 2010 TC: After reading this warning, why would anyone buy a bond?