The first half of 2022 is officially over… Good riddance. This past six-month period was one for the record books, and not in a good way.
Stocks officially closed out their worst six-month start to any year, going back over half a century. Many of us have never been in a market this volatile.
This has also been the only time in the last 50 years when both the S&P 500 and bonds have both been down more than 10%. That’s how unusual this moment in time is. And the reality is that there has been almost no place to hide…
Unless we were heavily invested in oil-related stocks or select commodities, as seen above, chances are that all of us are seeing red in our portfolios.
I know several readers have written in with their concerns, and rest assured I am reading your feedback.
I’ll be the first to admit that the speed and viciousness of this drawdown surprised me. And I know much of the volatility is showing up in the growth investments we usually profile here at Brownstone Research.
That’s why – as I announced yesterday – we’re stepping back from our usual editions of The Bleeding Edge. This week we’ll examine new investment strategies that will help us weather this volatility.
Right now, interest rates are rising. In June, the Fed raised its benchmark interest rate by another 75 basis points… the biggest increase since 1994. That brings us up to a range of 1.5%–1.75%.
And it’s looking like the Fed may raise rates again at their meeting, scheduled for July 26-27.
While these are still historically low rates, it’s easy to see how fixed-income investments can suddenly become more attractive. Many people have been frustrated by the measly 0.5% offered by “high-yield” savings accounts in recent years, for example.
Holding capital at 0.5%, in an environment where inflation is 8.6%, means that we’re literally losing money every month. Because we’re not earning at a rate higher than inflation, our purchasing power is diminishing.
That’s why it’s important we invest in assets that can beat inflation… and help increase our purchasing power. Today, I’ll show us three asset types that will provide us with the single best way of doing that over the next 6–12 months. The first of those is…
In these kinds of volatile markets, even companies doing everything right are being punished. And that’s making investments like convertible bonds look more appealing by comparison…
That’s because these investment vehicles have the safety and income of a bond, combined with the upside potential of a call option.
Here’s how it works…
A convertible bond is a fixed-income investment that delivers a yield to its investors. Like a traditional bond, a convertible bond delivers regular income and will return all our principal investment at its maturity date. But these bonds can do something else as well.
As the name suggests, these bonds can be “converted” into shares in the company that issues them. The conversion happens at a predetermined conversion ratio and conversion price. These bonds can be converted at any time during the bond’s life.
Here’s an example…
Let’s imagine a company issues a convertible bond yielding 5% with a maturity date of July 5, 2025 (three years from today). This bond has a conversion ratio of 10:1. That means we can convert the bond into 10 shares of the company stock.
Say the bond is priced at $1,000. We purchase 10 bonds for a total investment of $10,000. That means we can expect to receive $500, or 5%, every year.
And three years from now, we can reclaim all our invested capital. In a market like this, it’s a very appealing prospect. Our principal investment is protected, and we’re producing income as we wait.
But where things get interesting is the option to convert. Our 10 bonds give us the right to acquire 100 shares in the company. With a $10,000 investment, it means we would be able to acquire 100 shares at the predetermined conversion price.
When convertible bonds are issued, they include a conversion price above where the market is trading. Investors wouldn’t ever consider converting until the stock price has risen well above the conversion price.
That means that while market conditions are rough, investors can just be patient and collect the dividend payments from the bonds. In that way, we’re able to weather the storm, not have to worry about stock price volatility, not have to worry about getting our original invested capital back, and get paid a dividend while we wait.
But let’s consider the potential upside that is even more attractive than what I just described above.
Imagine we hold this fixed-income investment for two years, collecting 5% along the way. As we know, a lot can change in two years. If the conversion price was $100 on a bond at a 10:1 ratio, and the underlying share price recovered to $150, a $10,000 investment would have delivered us $5,000, or 50%. And because we collected a 5% yield for the preceding two years, our total investment return is $6,000, or 60%.
The beauty of this investing style is that it combines the security and income of a bond with the upside potential of a great technology stock.
And after reviewing the inventory of convertible debt currently on offer, it might surprise us to see the kind of opportunities out there.
Already we’ve begun to put together a core database of safe convertible debt offerings for technology companies. These offer yields anywhere from 5% to over 7%.
There’s still a lot of research to do. But my team and I have already found some attractive investments within that list.
The fact that we can convert them to shares, if prices rise, makes these very interesting in the current environment. That’s why we’ll be examining these kinds of bonds within Exponential Tech Investor in the near future. (Paid up subscribers can learn more about that here.)
And that’s not the only kind of fixed income that I want to put on readers’ radar…
How many normal investors know how to buy municipal bonds today… or even what they are? What if you went out and asked 100 of your friends… How many would have the answer?
Municipal bonds are a bit of an antiquated market, but they’re becoming more compelling in the current market environment.
These debt securities are issued by states, cities, and counties to finance projects like building schools, highways, or sewers. And like convertible bonds, the issuer returns regular interest payments up until the bond maturity date.
Municipal bonds are typically sold through a specialized broker. These brokers must be licensed in each state they deal in. And because they’re issued through state and local governments, they’re generally safer investments… unlike the stock market right now.
The safest municipal bonds tend to be in sewer and water. It’s important to focus on core municipal infrastructure that everyone needs every day – think utilities – and to stay away from things like municipal bonds for golf courses.
These might not sound exciting to readers used to investing on the cutting edge of technology and biotechnology… but there’s a good reason I’m mentioning them here.
Municipal bonds are a great option for fixed income. They often pay out twice a year… and we don’t pay federal taxes on our muni bonds.
And much like convertible bonds, their yields are rising to incentivize investors to buy them in the rising rates environment we’re experiencing.
Nominal muni bonds may offer rates above 3% right now… but given their tax advantages, our tax-equivalent yield might really be more like over 5% depending on where we live and our tax bracket.
Again, that’s not a yield that we should dismiss right now.
U.S. Savings Bonds
There is another fantastic option that I doubt most of us have heard of before. One of the very best fixed-income investments that anyone can make right now is to purchase savings bonds directly from the U.S. Treasury.
Most people don’t even know that’s possible, but anyone can go to treasurydirect.gov, open up an account and purchase any amount – to the penny – between $25 and $10,000.
And here’s the kicker, these bonds are now paying an incredible 9.62%. That’s not a typo. They are paying a fixed rate that is currently higher than inflation.
There’s only one catch, we can only buy a maximum of $10,000 each calendar year.
Otherwise, these Series I Savings Bonds will earn interest at that fixed rate for 30 years. There are a couple of other things that are useful to know:
Any investor can cash out their savings bonds any time after holding for one year
If you decided to sell before holding for a full five years, then the previous three months of interest are lost
For those who might be interested, there are two ways to buy these bonds:
Purchase them online (recommended) by opening an account at treasurydirect.gov
Purchase paper savings bonds each year at the time of filing your tax return. Fill out IRS Form 8888, indicate the amount of savings bonds that you’d like to purchase in $50 increments, and the paper bonds will be mailed directly to you.
That’s it. It really is that simple, and this is a fantastic fixed income return considering the market environment that we’re in right now.
These are just three options for exploring fixed income… and I plan to introduce these and more to my readers in the coming months.
And there’s one more reason we should consider these investments going forward…
Funding Our Risk
Generating regular income – whether it’s monthly, quarterly, or annually – can help fund our riskier, yet higher return investments.
I haven’t given up on finding bleeding-edge tech companies that could produce 10X returns for investors. This is just a moment in time where growth companies are not being valued. Large, institutional capital has been moving to safety due to the irrational and unpredictable government policies that we are seeing today.
This will swing back, and when it does, we’ll be ready.
And while we wait out this craziness, we can protect ourselves by ensuring a return that’s steady and predictable as well.
We can turn around and use our income generated to take advantage of depressed valuations in assets. Assets that still have incredible growth potential in front of them once the markets return to health… like high-growth small-cap stocks, early stage biotechnology, digital assets, and – of course – high-quality private investments.
That way, even if we continue to see short-term market volatility, we still have our original capital safe in convertible bonds or other forms of highly stable dividend or interest-paying investments … and we’ll be generating additional capital to put toward our next bleeding-edge tech play.
I know that markets like these are tough to stomach. There are days when we wish that we were short everything. But when we see this kind of market behavior and destructive policies, I find it helpful to remind myself that things are going to improve, the markets will recover, and we will get back to growth.
And until that time comes, there are smart moves that we can be making with our capital.
These investment ideas may not be on the bleeding edge, but I still find them interesting and useful, especially in a market and economic environment like this. I hope you do as well.
Editor, The Bleeding Edge
P.S. Do readers have questions about how these kinds of fixed income alternatives work? Would you be interested in hearing more? If so, please write in to [email protected].
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