Why Are You Still Clutching Your Bonds?

Physician's Money DigestNovember30 2003
Volume 10
Issue 22

The stock market took an upward turn this year, and it hasn't looked back yet. This year, stocks, not bonds, are your friends. If you have any doubt, just look at the table below comparing various stock indexes and bond returns for the first 3 quarters of 2003:

Lost Opportunity

These results include only the first 3 quarters. The past couple months have seen a dramatic rise in most stock indexes. If you have spent 2003 clutching your bonds close to your heart because you were afraid of losing more money in stocks, you have suffered this year from "opportunity cost." While you probably haven't actually lost money in your bond portfolio, you have suffered an enormous loss by missing a great opportunity to earn back what you lost in the stock market from 1999 to 2002.

At the top of the speculative bubble in 1999, investors only wanted to own stocks. At the bottom, bonds were the investment class with the greatest allure. People wanted peace of mind, but that's not what they got. Instead, bond prices have been highly volatile, up and down like a yoyo. Thirty-year Treasury bonds were up 7% in May, down 11% in July, and then up 5% in September. That wouldn't give an investor much comfort if they had bought bonds, thinking they were safe and stable investments.

In recent months, Federal Reserve Chairman Alan Greenspan has been purposefully talking interest rates down. That is why bond prices haven't collapsed already. When rates started to climb during the summer, Greenspan turned on his megaphone at the earliest sign of any economic upturn.

eral rule of thumb:

At midyear, the only sector carrying the US economy was housing. Fearing that any increase in interest rates would smother the housing boom, the fed was intent on keeping housing humming until the rest of the economy perked up. In addition to keeping rates low, the Federal Reserve board has been pumping money into the financial system since early this year. It takes about 9 months for an increase in the money supply to percolate through the economy.

Lower rates are helping the most highly leveraged American companies and consumers repair their balance sheets with new corporate bond offerings and new home mortgages that have much lower interest rates than the debt they are replacing. That is why Greenspan made it clear in repeated forums that the fed would not be raising interest rates anytime soon, and it hasn't.

Stocky 2004 Forecast

The atmosphere is looking up for the economy and the stock market next year. The cuts in payroll taxes that went into effect in August caused increased spending at retail stores almost immediately. Third quarter earnings reported in October have been generally upbeat. People are traveling and spending more. While unemployment remains a problem, corporate cutbacks seem to be abating. Paltry returns on money market funds are also pushing investors back toward the stock market.

It's impossible to predict exactly when the interest rates will move higher, but I'm sure they will before the end of 2004. As interest rates head higher, bond prices will head lower. Consider this year's paltry returns on bond portfolios to be a warning. Your biggest penalty has been the opportunity you have lost to rebuild your nest egg through stocks. Next year, you're likely to lose real money holding bonds. It's a stock picker's market.

Joan E. Lappin is chairman and chief information officer of Gramercy Capital Management in NYC. Gramercy has been ranked number 1 in the Nelson's Directory of Registered Investment Advisors and has reported year-to-date gains on its growth portfolios of 27.5% through September 30, 2003. She welcomes questions and comments at 212-935-6909 or jlappin@gramercycapital.com.

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