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Captivity? Let’s face it: most private investors avoid them. The mere mention of the word conjures up images of complicated mathematics and endless jargon. I mean, it’s a lot more exciting to be involved with the next big ai stock, isn’t it?
Investing in bonds is not for everyone. But that doesn’t mean investors shouldn’t have a basic understanding of how they work.
stocks versus bonds
Stripped down to its basic components, if I buy shares of a publicly traded company, I become a part owner. On the other hand, a bond is a debt instrument that is used to help raise capital. They are generally issued by governments and companies.
A link is made up of two elements. A promise to repay the initial amount in full when the bond matures and a fixed or variable interest payment, known as a coupon.
So far it sounds easy. But that doesn’t really explain why I should care about bonds if I only own stocks.
Importance of bonuses
Bonds issued by central governments such as the US Treasury and the Bank of England are always issued with a fixed coupon. Recently, the price of a 10-year bond (called Treasuries in the US and Gilts in the UK) has been declining as the coupon yield has risen.
Several factors have driven this decline, but a key reason is investors’ realization that interest rates are likely to remain elevated for longer than expected. Since inflation is far from controlled, an issuer needs to offer a higher yield to attract buyers.
Higher bond yields are important for the economy. Bond yields play a critical role in determining borrowing costs across the economy, including mortgage rates and corporate debt. They are the axis of the financial system.
An example that highlights this point is the run on several US and European banks earlier this year.
When depositors withdrew deposits a lot, entities like Silicon Valley Bank were forced to liquidate their Treasury holdings to raise cash. But because prices were falling, the value of those assets ended up being much less than what he would have received if he had held them to maturity. The result? A huge hole in the balance sheet.
Influence on my stock selection
The recent sharp rise in yields has meant bond investors are facing a third consecutive year of negative yields. This fact is unprecedented.
At the moment I avoid buying more shares of banks and insurance companies. This is partly due to its large bond exposure on its balance sheet. I don’t see mega cap tech stocks like Apple and microsoft as safe havens. The ratings there are too frothy.
I remain firmly convinced that we have not seen the end of the inflation narrative. That’s why I really like commodities businesses.
If a recession hits, central banks will undoubtedly print more money and reduce interest rates. But they cannot print energy, nor gold or silver. These commodities remain in short supply. The growing profits of companies like PA and Shell They are testimony to this.
And as for gold, it has thousands of years of history as the only truly scarce safe haven monetary asset. A superior alternative to any current bonus, in my opinion.
