Here's an apt description of today's bond market: It's a bull
market in lunacy.
The Federal Reserve's zero interest rate policy (ZIRP) has
pushed yields on bonds (NYSEARCA:BND) so low, it's also pushed bond
or income investors into assets they would've never dreamed of
owning. Subcategories within the bond market like emerging market
debt and high yield corporate bonds have soaked up billions. And as
a result, a nation of conservative income investors has been
converted into a nation of lunatics.
Instead of taking precaution, many income investors are piling
into higher yielding bonds without fully understanding the risks.
They're also missing other opportunities to generate high income,
but with lower risk.
Let's examine three ways income investors are getting into
High Risk Corporate Bonds
"Junk bonds" or "high yield debt" are corporate bonds issued by
companies with a shaky or un-established credit history. Naturally,
anyone lending their money to this type of company should expect a
very high yield to compensate for the additional credit risk. Is
This past week, the yield on the Barclays U.S. Corporate High
Yield Index (NYSEARCA:JNK) fell below 5% for the first time ever.
Are sub 5% yields adequately compensating bond investors for the
type of credit risk packed into junk bonds? Most people buying junk
bonds at today's yields have no understanding of just how dangerous
and volatile these types of bonds are.
Going Too Long on the Yield Curve
Another segment of the population is piling into long dated bonds
(20+year maturities) to get more yield. Unfortunately, prices for
long-term bonds and Treasuries (NYSEARCA:TLT) more vulnerable to
interest rate spikes. This leaves unsuspecting people open to a
world of hurt.
Our view of long-term Treasuries is as a short-term or temporary
haven and nothing more. When stock prices finally have their long
overdue correction, Treasury prices (NYSEARCA:UBT) will spike,
creating a short-term trading opportunity.
Betting on Shaky Countries
Here's another sign of lunacy in the bond market: Frontier market
countries (NYSEARCA:EMLC) are raising billions of dollars faster
than the flick of a switch.
reports that, "Rwanda sold $400 million in dollar-denominated
10-year bonds at an annual yield of just 6.87%."
Although Rwanda has grown rapidly, around 50% of the population
still lives below the poverty line. Approximately 90% of its
workforce works in the fields. "As a result, the country is heavily
dependent on foreign aid, which covers about 10% of gross domestic
It's a sure bet that when the next credit crunch arrives,
nations like Rwanda will default on their debt. Heck, evendeveloped
countries like Japan (NYSEARCA:FXY), Spain (NYSEARCA:EWP), and
Italy (NYSEARCA:EWI) have the same acute risk!
High Income, Lower Risk
There are much better strategies for generating high income than
three examples you just read about. Selling covered call options is
just one example.
Since the beginning of the year, our
Income Mix Portfolio
has generated over $3,000 of monthly income. How do we do it?
Instead of chasing yields in high risk bonds, we use a lower risk
strategy by selling covered calls. It allows us to still collect
dividends on the underlying ETFs and to cushion our portfolio
against market declines.