Time for Reaping
By Julien B. Booth
May 5, 2017
Good Afternoon:
I hope this note finds you doing well.
As age becomes less important and wisdom (You Win or Learn) accumulates you come to realize the importance of subtle timing. The advent of micro-second trading has certainly reinforced this point – a second late, a billion dollars short they say.
We have no idea what may transpire tomorrow, much less next year; however, we do understand the power of gravity. 8+ years into an expansion, growth tends to not accelerate, but moderate.
Yield spreads* are one mechanism for measuring risk – and how much you are being compensated to take said risk. In 2015 risk spreads (re: oil collapse) pushed the risk premium on higher-yielding bonds (BB+ or below) to multi-year wide relative to Treasury bonds. As yield spreads widen the corresponding bond prices go down (cheapen).
The chart below depicts the reaction of bond prices since mid-2012. At the peak spread of the recent cycle, high yield bonds were yielding 5%+ over similar-maturity Treasury bonds. In short – they were pricing a lot of risk (and alot cheaper to buy).
Value investors generally despise overpaying for anything, hence they like widening spreads for finding opportunity. We have exhausted such opportunity in the current market as the spreads to Treasury bonds are at the exact opposite – historically narrow (very high) bond prices.
With target returns met (6-8% range) in 2017 we are thrilled to be at a point to Reap some profits from the higher-yielding securities and building cash balances.
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.