The mantra of the "chicken money" investor is: I'm not so concerned about the return ON my money, as I am about the return OF my money!
It's a reminder I have issued frequently over my many years of writing a column. "Chicken Money" is nothing to be ashamed of. It's simply money you cannot afford to lose, so it belongs in short-term, safe investments, such as insured CDs, money market deposit accounts, and Treasury bills.
Sadly, the Fed has kept downward pressure on interest rates for so long that many people have searched for much higher yields - not recognizing the additional risk that comes with heftier returns.
That's changing now, as the high-yield bond market comes under tremendous pressure. Many of those higher-yield issuers (we used to call them "junk bonds") are in industries related to oil exploration and drilling. But with the collapse of oil prices, the issuers will have a tough time getting the money to pay the promised interest. And so their IOUs, their bonds, don't look so attractive anymore.
The professional money managers who accumulated those bonds in bond funds are now trying to sell the bonds, at lower prices and with little success. The exits are crowded. Some of the best known and famously-managed bond funds are taking steps to limit redemptions by investors. The idea that you can be first out the door doesn't work when the entire crowed is rushing to the exits.
The pricing situation is made worse by the Dodd-Frank banking regulations that require banks to maintain more capital. Banks have cut back on taking positions in various securities (like junk bonds) in order to meet new capital requirements. That means there are fewer buyers out there to take the opposite side of the trade.
High yield bond prices have fallen dramatically in the rush to sell. Bids have fallen as much as 10 percent from one trade to the next. In many cases, there simply are no buyers. And suddenly those high yields investors were harvesting don't offset the price losses in the bonds they own.
It's not that most of these bonds are likely to default, although some highly leveraged companies might do that. It's mostly that the lack of liquidity in the marketplace means bond holders can't sell. Now you see the true price of lack of liquidity. Suddenly, those stodgy, much lower-yielding U.S. Treasuries look a lot more attractive!
In the midst of this bond crunch, the Fed is debating raising interest rates. How will that work out? It will make the U.S. dollar more attractive, stronger -- and make our exports more expensive to foreign buyers. That's likely to slow sales, meaning U.S. manufacturers will lose profits, and American workers will lose jobs.
The Fed's move toward higher rates will make those "chicken money" investments look just a bit more attractive. It's a shame that those who chased higher rates in the junk bond market won't be able to get all their money back to put it into their chicken money bank accounts. They may be taking losses of 30 percent or more if they sell now.
That is the price for taking the risk they didn't understand in order to get higher returns. Or as a wise observer of the markets always says: "Risk is the price you never thought you'd have to pay." And that's The Savage Truth.
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It's a reminder I have issued frequently over my many years of writing a column. "Chicken Money" is nothing to be ashamed of. It's simply money you cannot afford to lose, so it belongs in short-term, safe investments, such as insured CDs, money market deposit accounts, and Treasury bills.
Sadly, the Fed has kept downward pressure on interest rates for so long that many people have searched for much higher yields - not recognizing the additional risk that comes with heftier returns.
That's changing now, as the high-yield bond market comes under tremendous pressure. Many of those higher-yield issuers (we used to call them "junk bonds") are in industries related to oil exploration and drilling. But with the collapse of oil prices, the issuers will have a tough time getting the money to pay the promised interest. And so their IOUs, their bonds, don't look so attractive anymore.
The professional money managers who accumulated those bonds in bond funds are now trying to sell the bonds, at lower prices and with little success. The exits are crowded. Some of the best known and famously-managed bond funds are taking steps to limit redemptions by investors. The idea that you can be first out the door doesn't work when the entire crowed is rushing to the exits.
The pricing situation is made worse by the Dodd-Frank banking regulations that require banks to maintain more capital. Banks have cut back on taking positions in various securities (like junk bonds) in order to meet new capital requirements. That means there are fewer buyers out there to take the opposite side of the trade.
High yield bond prices have fallen dramatically in the rush to sell. Bids have fallen as much as 10 percent from one trade to the next. In many cases, there simply are no buyers. And suddenly those high yields investors were harvesting don't offset the price losses in the bonds they own.
It's not that most of these bonds are likely to default, although some highly leveraged companies might do that. It's mostly that the lack of liquidity in the marketplace means bond holders can't sell. Now you see the true price of lack of liquidity. Suddenly, those stodgy, much lower-yielding U.S. Treasuries look a lot more attractive!
In the midst of this bond crunch, the Fed is debating raising interest rates. How will that work out? It will make the U.S. dollar more attractive, stronger -- and make our exports more expensive to foreign buyers. That's likely to slow sales, meaning U.S. manufacturers will lose profits, and American workers will lose jobs.
The Fed's move toward higher rates will make those "chicken money" investments look just a bit more attractive. It's a shame that those who chased higher rates in the junk bond market won't be able to get all their money back to put it into their chicken money bank accounts. They may be taking losses of 30 percent or more if they sell now.
That is the price for taking the risk they didn't understand in order to get higher returns. Or as a wise observer of the markets always says: "Risk is the price you never thought you'd have to pay." And that's The Savage Truth.
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