There’s no doubt this investment is cheap. But you could say that about countless investments right now. What makes this different is the amount of money going into it. The Bank of England is about to pump £50 billion into this market and we want to profit from this buying binge.
We call it the “King Trade”, after the Bank’s governor, Mervyn King.
The opportunity in corporate bonds
The coming bull market is in corporate bonds. These are effectively IOUs on company debt that investors typically buy for the income.
In normal market conditions, interest rates and bond prices work in opposite directions. Traditionally, to make money in this market you would hold a high yielding corporate bond at a time when UK interest rates are falling. When rates fall, the fixed coupons of these bonds become more attractive and the value of bonds rises.
This isn’t happening as investors are fearful of the market as a whole and the risk of default by companies. Fear that bonds will not pay back the initial stake, or principal, is at historic highs. However, for this to happen, things are going to be worse than in the 1930s.
We agree that times are tough, but in their attempts to stop the rot, policy makers have introduced bailouts, stimulus bills and relentless rate cuts. That’s why we doubt the default rate will be as bad as the 30s.
The “flight to safety” away from the corporate bond market is an overreaction that we believe creates an opportunity to profit.
The 50 billion pound spending spree
The Bank of England is committed to supporting the bond market. It has set up an Asset Purchasing Facility that will buy corporate bonds, commercial paper and syndicated loans. The initial sum – i.e. expect further spending sprees in the future – of £50 billion was approved last month.
That is a lot of money in the corporate bond market. According to strategist Mike Lenhoff at Brewin Dolphin, £50 billion represents 60% of institutional inflows in 2007, which was a good year for corporates. 2008 figures are yet to be finalised, but according to Lenhoff it is likely to be well below £50 billion. So the “King trade” injection is no small sum – enough to drive prices higher… and kick off 2009’s next bull market.
Bull markets are not about valuation, they’re not about fundamentals. They are about buyers putting down hard cash. And that’s exactly what we are looking at here.
Steer clear of these corporate bond pitfalls
So, with the opportunity clear, what’s the smartest way to play corporates?
Don’t buy direct – Buying direct is an option to only the most committed corporate investors. While many investors would love to buy into a single issue in Tesco, for example, this could be out of reach. The minimum investment for new issues of high quality corporate is sometimes as much as a €50,000. At the lowest end, you will find purchases available in tranches of €1000. But let’s not forget that a single corporate bond would not be a well-diversified exposure to this market.
Don’t buy ETFs – A popular, but flawed route to corporates. Low costs and high liquidity are major pluses to the growing exchange traded fund market. Unfortunately, there is only one ETF tracking UK corporate bonds and that’s one to miss. The iShares £ Corporate Bond ETF (ticker symbol SLXX), for which the iBoxx Sterling Liquid Corporate Long-Dated Bond Index provides a benchmark, consists approximately of 68% financials and banks. As you can imagine, this many banks and financial positions make for a volatile fund and we’re trying to avoid volatility with this investment. Despite many bank bonds having government guarantees, I would recommend staying away from this ETF.
The best, and for many investors the only, way to play corporate bonds is to go through the fund managers. They are the gate-keepers to what looks set to be the bull market of the year.
And Richard Woolnough of M&G is one manager to keep an eye on. His Corporate Bond fund has outperformed the index so far this year and the Bank of England hasn’t even started buying yet. When they do, we could see the bull emerge.
Best wishes,
Theo Casey
For The Right Side
Editor’s recommendation: The Fleet Street Letter has just released what it believes is the best way to play the coming £50 billion “King Trade” in corporate bonds. You can receive it by return email when you take a trial subscription here.
MARKET NOTES
Sterling could fall a further 16% from here
BY SHIVVY ARORA
The pound may have shown some resilience of late, but low interest rates and the Government’s plans to flood the economy with cash means there’s only one way for it to go – down.
All eyes are on the Bank of England's rate decision tomorrow, where it is expected to cut rates to 0.5 percent.
The chart below shows the value of the pound measured against its fiercest rival, the US dollar. As you can see, from the peak up to now the pound has already lost more than 40% over the last six months.
From bad to worse: Sterling’s troubles continue… 
Source: Bloomberg
The pound is “finished” according to global investor Jim Rogers in January. Analysts believe that it could weaken against the euro to as little as 93 pence in the next three months – that’s a 16% fall from current rates.
The Bank of England’s plans to boost money supply is also no doubt going to hurt the pound. With investors already looking elsewhere for yield and traders dumping sterling for the euro and dollar, the currency’s fate looks sealed.
Right now is a good time to hedge your bets with exposure to different currencies. It’s one of the ways to protect your wealth from the coming storm.
The Daily Reckoning – Angela Merkel to Eastern Europe: Drop Dead!
BY BILL BONNER
You remember that famous cover story of the New York Daily News? New York was nearly bankrupt in 1975. The city asked the feds for a bailout. To his everlasting credit, Gerald Ford had the backbone to just say ‘no’.
Had he given the city a bailout Ford might have won his race against Carter. He believes that that headline cost him the New York vote...and the election. Then again, had he given New York a bailout...the city might be more like Detroit.
The kindness of strangers is one of life’s delights, but once you begin to count on getting something for nothing you are on the road to Hell. At least, that is our view here at the Daily Reckoning.
Welfare ruined the lives of millions of people. (More on that... below...)
Easy credit – coming largely from the Fed and the kindness of strangers in Asia – ruined the American consumer.
Bailouts, handouts, bribes and giveaways threaten to sink whole industries.
And now the whole world economy will be ruined by printing press currency – something-for-nothing money coming from the central banks.
But that will take time... maybe years. For the moment, we are enjoying the show...
Europe is plagued by debt too – just like the US. Individual households are generally in better shape than those in America, but governments tend to have more debt than the US. And in the fringe countries of Europe – Ireland, Spain, Greece, Italy, Poland, the Ukraine – consumers borrowed far too much money to buy houses.
Unemployment is soaring to 15% of the workforce in Spain. Irish banks are going under. And in Eastern Europe, the problems are worse. Typically, a man who wanted to buy a house found that he got a better interest rate if he took out a mortgage in euros than in his home currency. In Poland, for example, many homeowners must now make their mortgage payments in euros, while they earn their money in zlotys. As the financial crisis developed, the zloty fell against the stronger euro, by half. This leaves the Polish householder paying twice as much on his mortgage.
Read on...
To read the Daily Reckoning in full, click here.
P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.
