Let's have a real conversation.
When we are talking about bonds, we are talking about a contract. This contract creates a security. This security becomes a liability on the issuer's balance sheet and an asset on the investor’s balance sheet or brokerage statement. Cool?
After issuance the price and yield of the bond will change based on several factors. For today's purpose it is important to know that the price of the bond and the yield of the bond interact like a teeter-totter. The price of the bond and the interest rate of the bond are on opposite sides. So when yields are rising, the price is declining.
When an issuer’s ability to make interest payments or payoff the debt is impaired, the bond will fall in price and the yield will go higher. Market participants, who actually do research, will sell in anticipation long before any defaults actually take place. This is possibly what is happening today in the picture above.
So why am I talking about this now? Well timing is everything. With 99% of all business media focused on the stock market, I thought it is important to remind everyone of what owning a stock certificate actually means. Think of stocks like the youngest child in a family of eight kids. You get the scraps. So when you think of the capital structure of a business and who gets first dibs on the cash flow - it is the bond holder. After all of the other business expenses and interest are paid, the stock holder has any claim on what is left. This is why when the business cycle slows, cash flows decline, and the old saying, “only when the tide goes out do you get to see who is swimming naked” comes to play.
The business cycle hit a brick wall and it is far too soon to know with any kind of accuracy what the range of outcomes might be. I’ve never invested during a pandemic - have you? The most prudent course is to observe how assets are being priced. Right now, I am seeing yields in certain countries in Europe increasing relative to other countries. This is telling me the stresses in the system are increasing not decreasing. So if entire countries begin to default, if municipalities begin to default, and if companies begin to default on their debt, do you not think this will have a negative affect on stock prices? If you begin to see the big kids at the table going hungry, what do you do?
Best,
P. Franklin, Jr.