Income Investing


The Great Bond Shortage

Jeffrey R. Kosnett

Big businesses don't need to borrow much when they can easily tap their bulging cash coffers.



It gets clearer by the day that your bond principal is safe from the interest-rate termites. If rates advance this year, the climb will be in fits and starts, and it will end with much ado about little.

See Also: Kiplinger's Interest Rate Outlook

I’m not selectively decoding Federal Reserve communiqués. Rather, my reasoning is as old as economics itself: The supply of bonds isn’t sufficient to keep up with demand. This imbalance keeps prices high, and that means bond yields are stuck on low.

I say this with an absolutely straight face, despite knowing that the amount of domestic debt outstanding is just shy of $40 trillion. That figure includes $12 trillion of assorted Treasury securities. The rest is federal and private mortgage-backed securities, government-agency debt, corporate bonds (both junk and investment-grade issues), municipal IOUs, and commercial paper and similar filler for money market and ultra-short-term income funds.

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In fact, the domestic debt marketplace is almost double the size it was ten years ago. You might think that would mean bond issuers must beg people and financial institutions to buy their obligations at any price. Sorry, but that’s not the case. It’s a bond seller’s market. In late February, Cisco Systems sold $8 billion worth of new bonds. Comcast recently sold $2.2 billion worth, and some analysts say that it could have found takers for $12 billion despite paying just 3.6% for ten years and 4.8% out to 2044. “Surprising as it may seem, there’s a lot more demand for fixed income than there’s ready supply, and I can’t see anything on the horizon to change that,” says Dan Heckman, senior bond strategist for the division of U.S. Bank that manages money for wealthy investors.

Heckman says the squeeze is tightest in tax-exempts: Few muni bonds are being issued, and funds aren’t selling as many bonds into the secondary market as they did the past two years to meet shareholder redemptions. And with the federal budget deficit shrinking (at least over the short term), banks, insurers and pension funds are elbowing one another to get at new Treasuries before their yields go lower.

Although statistical evidence backstops my view that bonds have broad and deep support at current rates and prices, it’s possible to fudge figures. So I asked pros, such as Heckman, who regularly troll the bond bazaar whether they have to scramble to meet clients’ yield wishes. They consistently answered yes.

Hustling for munis. Dawn Daggy-Mangerson and Jim Grabovac, of McDonnell Investment Management, a Chicago-area firm, are hustling to find muni bonds, especially in short and medium maturities. “It is a slog trying to access new names in the market because issuance is so slim,” Daggy-Mangerson says. Municipalities are not borrowing much because tax receipts and fee income are up, and they have already refinanced gobs of older, higher-rate debt.

Corporations floated record volumes of bonds in 2012 and again in 2013. They, too, are now pulling back: Bank of America Merrill Lynch sees a 16% drop in issuance of investment-grade bonds this year. The two-year borrowing binge was a pre­emptive strike against a spike in rates that didn’t happen. Big businesses don’t need to borrow much when they can easily tap their bulging cash coffers to pay for acquisitions, buy back shares and boost dividends.

Junk bonds are also scarce, although the expanding economy puts investors and borrowers at ease about credit risk, fostering additional offerings. But demand is off the charts. Two ace junk-fund managers tell me they can’t get nearly the volume they want when a desirable new issue comes to market. No wonder a growing number of bond managers tell me that their best income ideas are dividend-paying stocks.



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