TRANSCRIPT: The 2017 Bond Market Forecast w/ Bond Strategist Steve McDonald

Announcer: It’s time for Marc Lichtenfeld’s Oxford Club Radio, the hardest-hitting half-hour about you and your money. And now, here’s Marc Lichtenfeld.

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 Marc Lichtenfeld: Welcome to Marc Lichtenfeld’s Oxford Club Radio. I’m Marc Lichtenfeld. Glad you’re with us. We’ve got a fantastic show for you today. If you are a bond investor, you don’t want to miss my interview with Steve McDonald coming up in just a little bit. He’s The Oxford Club’s bond expert and the editor of Oxford Bond Advantage, and we’re going to talk about how you handle bond investing these days when interest rates are rising. They’re expected to rise even more. It’s a bit of a dangerous space right now, and so Steve will talk about how you navigate that area because let’s face it, even in a rising rate environment, you certainly want to have some of your portfolio in bonds, right? You don’t want to be 100% in stocks or, you know, 90% in stocks, 10% in gold or whatever allocation. You want to have some bonds, but it’s tricky in a rising rate environment. So we’ll talk with Steve McDonald about how you handle that and where he sees value in the bond market.

And as always, I want to tell you that you can get in touch with me. We’d love to hear from you, so give me your feedback, give me your questions. You can email me by going to OxfordClubRadio.com and clicking on “Contact.” Shoot me an email, whatever’s on your mind. You can follow me on Twitter @StocksNBoxing. You can leave comments here on Oxford Club Radio right under the episode that you are listening to, and we hope that you will do so because, like I said, we love getting your feedback and want to know what’s on your mind.

So I want to kick off things today. Talk about an interesting situation with our president-elect. As everybody knows, Donald Trump is a billionaire businessman, and it’s fascinating all these conflicts of interest that are – I don’t want to say “coming up,” because nothing new has come up, but… he’s got all these holdings and he’s supposed to have this blind trust, which everybody knows is not blind at all if his kids are running the blind trust, so that’s just a complete joke, but he’s really the first president that we’ve had who kind of has had these problems, who has had so many holdings, so many business interests. I mean, if you look at past presidents, you know, Barack Obama and George W. Bush, they weren’t really career politicians, but they’d been politicians for a number of years. Before that, Bill Clinton, the first George Bush, they were truly career politicians. You had Ronald Reagan, Jimmy Carter… also not career politicians, but had been in it long enough.

So Trump is really the first person who really when he came into office, his first political office, he had this whole other life and business interest. And so even apart from the blind trust situation, which is a whole other issue, he owes a lot of money to other institutions. And during the election, it came out that he owed money to some Chinese banks that are owned by the Chinese government, and that’s a whole other situation. I don’t even want to get into that. But what I think is fascinating is that he owes hundreds of millions of dollars to well over 100 different companies, institutions, what have you. And what’s really interesting to look at is what happens if things go badly in the economy and some of those loans go belly-up, because Donald Trump has signed for some of those loans personally, where he is personally backstopping those loans, meaning that on some of these loans, if they go belly-up, he is personally on the hook for repaying millions of dollars.

Now, I’m assuming, even though he’s a shrewd businessman, not every single loan that he has taken out is a fixed-interest loan. I’m sure many of them are variable. So what happens if we get into a situation where inflation takes off, interest rates take off, and these loans adjust to higher interest rates, but perhaps the economy isn’t doing particularly well? Let’s say this is like the 1970s, the late 1970s where the economy stunk but interest rates were through the roof. What happens if we get into a situation like that? Maybe not even that extreme, but just the economy isn’t particularly hot, it’s limping along, but rates have gone higher, and now some of these loans are expensive, the companies that are behind the loans, some of his businesses, can’t pay them, and he’s on the hook for them personally. I mean, what kinds of conflicts of interest does that raise? Let’s say he owes – and I’m just making up numbers and institutions here, but let’s say he owes $5 million personally to Deutsche Bank or he owes $3 million to Citibank. I’m not sure – you know, certainly I guess he could just write a check, but he has been broke before, even though he had all these holdings. He has been busted.

So it just creates a very unusual dynamic where the president of the United States could enact policies to bring rates down, to put pressure on the Fed… Who knows what could happen if a president – I’m not just saying Donald Trump, I’m saying any president in this situation – is in a bad financial situation and now is bleeding money because of his business interests and the economy. And again, I’m separating foreign interests or any of that kind of stuff. I’m just talking about, you know, macro issues. He owes a lot of money, the economy isn’t doing well, what happens? It’s just a fascinating thing to think about because we’ve never been in this situation before. Even George W. Bush was a very wealthy man, had various holdings, but those things were in a blind trust, he had – as far as we know – no involvement with any of that, and as far as we know he was never concerned with any of these kinds of things. No president has, again, as far as we know. Who knows what goes on behind closed doors, but nothing’s ever been made public. In this situation, everything is public. He talks about his holdings, and the media certainly brought it up. So it’s just a fascinating thing to think about and something to keep your eye on. If rates go up and the economy is not hot and some of his businesses aren’t doing well, it could be a really, really unusual situation for what will then be President Trump.

All right, speaking of interest rates, we’re going to talk bonds with Steve McDonald in just a minute. This is Oxford Club Radio. I’m Marc Lichtenfeld. Stay with us.

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Marc Lichtenfeld: Welcome back to Marc Lichtenfeld’s Oxford Club Radio. I’m Marc Lichtenfeld. Our guest this week – this is an interview you cannot afford to miss – Steve McDonald. He is the editor of Oxford Bond Advantage and The Oxford Club’s bond expert. And, Steve, I’m so glad you’re with us here in the first show of 2017 because I can’t think of a more important issue than bonds. So many people are invested in bonds and bond funds. Interest rates are starting to move higher. I guess start off by giving us your broad take on the bond market for 2017.

Steve McDonald: Well, thanks for having me, Marc. It’s nice to be here. My broad take, Treasurys are going to continue to sell off. We’ve already seen a significant sell-off between the election and today. The 10-year yield has gone from 1.8 – it as was high as 2.6. I think it’s around 2.4 as we’re talking. And I think they’re going to continue to sell off because finally the rotation function in bonds is working. In other words, the flight to safety and the flight to risk that everybody’s familiar with, I’m sure. The flight to risk is finally working. I mean, for eight years, bonds were going up in price and stocks were going up in price. This wasn’t supposed to happen.

So on one level, I’m happy to see the sell-off. I think we’ve needed higher yields for some time, especially for people who need  bonds for guaranteed income. But yeah, I think we’re going to see Treasurys selling off quite a bit this year. I’m looking for 3% to 4% on the 10-year, which means we’ve got a lot more selling to do. And on the other end of the market, on the corporate market, just the opposite is happening. I mean, we’ve seen very solid prices since the election. In fact, we’re seeing quite a few bonds moving up in price. Not huge moves, but considering how much the Treasurys have sold off… but that’s exactly how corporates are supposed to act. You know, we are in an environment now where people are calling for improving fundamentals, both at the company level and, you know, the national economic level, and that’s what corporate bonds respond to, fundamentals. They will go as high as the company’s fundamentals will allow them, and so, no, there’s pent-up demand for good yield, so I think we’re going to see a good solid corporate market this year, which is how it’s supposed to work. It’s not attached to the Treasury the way munis are, and so yeah, overall I think we’re going to see selling in Treasurys. I think we’ll see a solid corporate market.

Marc Lichtenfeld: Let me ask you about the corporates. Are there certain areas that you’re seeing value right now in corporates or areas that you’re particularly interested in?

Steve McDonald: Yeah, there’s a lot of value right now in oil, oil services and drillers. In fact… since not just since the election, but since about March, we have seen these bonds for these companies in these industries moving up 4%, 5%, 6%, 7%, 8% in a week. And we haven’t seen a sell-off in them yet. I mean, we’ve seen a few level off. The larger ones haven’t been moving quite as much, but when you get into some of the offshore drillers, there’s huge value there right now. And there’s lots of bonds available. In fact, most of the inventories I look at right now are full of oil drillers, oil services, even the folks who provide helicopter rides out to the rigs. Their bonds have just gone up. For example, a big company like Chesapeake, it went from $0.17 on the dollar to almost par right now since March. That’s how much some of these have moved up. But there’s still lots of room on the upside because oil really hasn’t completed its turnaround, which has been driving this. You know, I’m looking for oil in the $65 to $70 range, so we’ve got a good $10, maybe $15 more, which should show considerable capital appreciation in these oil-related bonds.

Marc Lichtenfeld: We’re talking with Steve McDonald. He’s the editor of Oxford Bond Advantage. Steve, let me ask you about munis because so many of our listeners are invested in munis and interested in, with rates going higher, and particularly with potentially lower individual tax rates, does that make munis less attractive now?

Steve McDonald: You know, munis are a funny thing. There was a time in my career when I was still working as a broker where I thought everybody should own munis. I don’t think anybody should pay taxes in retirement on their income if they can help it. And so I was a huge proponent of municipal bonds. But back in the ’90s when I was selling these things to my clients, they were paying 5%, 6% and 7% on AAA-rated, you know, general obligation bonds. And I couldn’t sell them because people thought the crazy rates of the ’80s were coming back. You know, there’s always that boogeyman – and right now the boogeyman in the market is the bubble concept. Everybody’s waiting for a bubble to burst. So, you know, people miss huge returns.

But more direct to your question, are the lower rates going to affect it? Not really. You know, it’s always been a better deal in munis if you have a high income – high taxable income, obviously. But munis offer so much security. I mean, it is so rare to see a municipal bond default. And even when they do – I only know of three recent examples, say in the last five years – and in every case, they’re insured, which most municipal bonds are now. In every case, they either got all their principal back or, in one case, they got their principal and their interest. So from a tax standpoint, if you’re in the higher tax brackets, no matter where they go, we’re still going to be paying at least 28% in the higher bracket, and that’s always been a nice threshold for municipals.

But on the other hand, I think we’re going to see considerably higher rates because those same bonds that I was selling back in the ’90s to my clients that were paying 6% and 7% are paying about 0.5% now. That’s how much these bonds have gone up in value, and they’ve got to sell off. Munis follow Treasurys almost point for point when there’s a rate increase, so we’re going to see significant selling, I think, in munis. Not huge. I mean, we’re not going to have a panic out there, but we’re going to have better yields than 1% and 2%. And so even if you’re in, let’s say, a 15% tax bracket, if you can get 4% on a good quality municipal bond with the security they offer, I don’t care what your tax bracket is, it’s probably not a bad idea to have some of these things. And nobody – you and I both know this, Marc – nobody wants to pay taxes on income. They just don’t want to do it.

Marc Lichtenfeld: No. No, that’s for sure. And especially the people in the higher tax bracket, I think it’s very safe to say rich people don’t like paying taxes, so interesting stuff on munis. We only have about a minute left, but I did want to ask you real quick about bond funds. You and I both are not fans of them because rates are going up, but so many people are invested in them. So as rates are going higher, how should people unwind and where should they put their money if they want to stay in fixed income, because so many people do need fixed income?

Steve McDonald: Right. No, I am not a fan of bond funds of any kind. Now, there are a few exceptions. There’s one that Alex Green recommends. It’s the Vanguard fund, and it’s in the Gone Fishing portfolio at The Oxford Club. It’s a pretty good fund. There’s not much leveraging, it’s good quality. The key to bond funds is this: In order to get people to invest in bond funds, they’ve got to leverage it, which means they’re borrowing against the assets, and they have to go way out on the maturity to get yields high enough to make people interested. I mean, nobody buys a bond fund saying, “well, let’s see, the market averages 1.5%. I want a bond fund that pays 1.5%.” No, they want 4%, 5% and 6%. They’re kind of digging their own graves. When this market sells off this year – and it’s going to – these bonds, these municipals, these Treasurys are going to sell off, they’re going to get crucified. So where should you be right now? Individual bonds. You want to own munis, buy individual munis. You’re more comfortable with corporates, you want the higher yields they pay, little more risk than munis? Buy the individual bonds. Not difficult. You know, it’s no more difficult than buying a stock, but get out of those funds.

Marc Lichtenfeld: Yeah, I agree 100%, and I’ve always really liked the way that you do it with the corporates where you’re usually buying the corporates for less than par so there’s even potential for some upside there, and I think you do a great job. So we’ve got to leave it here. We’re up against the clock, but thanks very much for joining us, and let’s check back in with you a little bit later in the year.

Steve McDonald: Thanks, Marc. Have a great day.

Marc Lichtenfeld: All right. That’s Steve McDonald, The Oxford Club’s bond expert, editor of Oxford Bond Advantage. When we come back, we’re going to talk about seven rules for trading for 2017 I think you should pay attention to. This is Oxford Club Radio. I’m Marc Lichtenfeld. Stay with us.

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Marc Lichtenfeld: Welcome back to Marc Lichtenfeld’s Oxford Club Radio. I’m Marc Lichtenfeld. As you’re listening to this right now, I am in San Francisco, about to attend the J.P. Morgan Healthcare Conference, or actually the conference might be underway, depending on when you’re listening to this. And so next week I will be talking about the conference and all the things that I learned there. It’s really an intense week where I have a couple dozen meetings with CEOs, traders, fund managers, etc. lined up, so I will talk about what I am learning there and the mood, because I’m anticipating a mixed bag. On the one hand, you’ve got the 21st Century Cures Act, which is going to help drug companies and biotech companies get their drugs approved quicker. That’s certainly going to be good for business. On the other hand, the repeal of Obamacare is leaving a lot of things up in the air. There’s a lot of unanswered questions, and so I’m going to kind of be gauging the temperature, if you will, of how the executives are thinking about their businesses going forward. It should be a fascinating conference, so we’ll be talking about that next week.

But this week I want to get into seven rules for trading in 2017, and this week in Barron’s, there was an article by Steven Sears where he talked to Michael Schwartz, who is the Oppenheimer option strategist, and I think Schwartz has these seven New Year’s resolutions, but I think they’re applicable to anybody, not just for options. And so I’m kind of adapting these as seven trading rules that I think you should be paying attention to, and they’re really, really good.

So the first one, and I think this is probably the most important one, is remember there’s always time to make money. The hard part is not losing money. Remember there’s always time to make money. And so many investors see an opportunity and they jump on it and they don’t bother to do their research or they don’t bother to, even if they’re following one of our trading recommendations, they don’t bother to read it. They just see the ticker symbol and they jump on it, and we certainly appreciate that vote of confidence, but understand what you’re getting into because sometimes, especially in my recommendations, I might say, “this is an especially speculative position,” or “this is a very binary position.” Either it’s going to spike or it’s going to tank. Other times it’s more measured. It’s just kind of a regular stock and we think it’s going higher, but the chances for huge gains or huge failures are a little bit less.

So understand what you’re getting into. Take the time to read about it. Don’t chase stocks. If we’re recommending a stock at $50 and by the time you read it, it’s at $51, and we say don’t buy it above $50, don’t buy it above $50. There’s a reason. There’s a risk-reward ratio usually or some valid reason that we have for not paying too much for the stock. And yes, sometimes you’ll miss it. Sometimes a stock will never come back down. Many times it will, though. Very often it will come back down after the initial kind of buying frenzy, so be patient. And again, whether it’s our stocks or anything that you’re reading about or hearing about, take your time to understand what it is that you’re buying and know that there’s always time to make money, there are always other opportunities if you miss this one. That’s one great thing about the market: There are a lot of stocks out there. There’s always a bull market somewhere.

So, No. 2, risk is real. Risk is not risky if it’s understood and defined. So what this means to me is when you do get into a trading position, know ahead of time what your risk is. That’s why we put in stops for so many of our positions, for almost all of our positions. In most of our services, they’re 25% stops. So we know that the risk is 25%. Now, for me, on some of the very speculative biotech stocks, sometimes that risk is higher and I’ll let you know, “hey, if the drug does not get approved, this stock is going to gap much lower. It could be cut in half.” So with that 25%, even though you have a stop, you have to be ready for the possibility that the stock could be cut in half. But know what the risk is before you enter the trade. Don’t go into a trade and then figure out how much you could possibly lose if things go wrong or find out and get surprised. “Well, I didn’t know I could lose that much.”

Understand what that risk is, either by having a stop or, again, kind of going back to the first point, reading about it and understanding what could go wrong and how much the stock could drop if it goes wrong. Because the key to making money in the trade is not being right every time. Nobody’s right every time. The best hedge fund managers and the best traders, some of them are right one out of three times, but they manage their positions so that they keep their gains large and their losses small. So as long as you’re doing that, as long as you’re managing the risk, you can make a lot of money without being right even half the time.

No. 3, make certain that you understand your own investment objectives. Could you explain what you’re doing to your children? I think this is a great one, and to me, this means don’t let a trade become an investment. And we’ve all been there, where you get into a stock and you think it’s going higher and it doesn’t work out, and this was supposed to be a one-, two-, three-month trade and now you’re sitting on it for six months and you’re down 15% and it just kind of isn’t going anywhere – or worse, you’re down 25%, 30% and you’ve dismissed your stop, you’ve ignored it. And now you’re holding this thing and you’re holding it for a year or two years, hoping that it comes back, and it never does. It never does. So understand your reasoning, your timing for getting into a trade. If it’s a trade, don’t let that trade become an investment. Understand your objectives.

No. 4, review your previous year’s investment performance. Did you outperform the market or lag in your benchmark indexes? And this goes back to kind of understanding your strategy, understanding what mistakes you’ve made, what was working for you, what was not working, and it’s important to be flexible. Let’s say you’re a technical trader and you use moving averages, for example, and you outperform the market. Don’t think that that particular strategy’s always going to outperform the market. No technical indicator, no fundamental indicator, it’s not like value always outperforms growth. So you have to be flexible, but understand what works, and especially what doesn’t work. If you have a certain style of trading, if you’re trying to be a day trader and that’s not working for you but you’re making more money swing trading, then do that.

No. 5, resist seductive takeover stories or rumors. Don’t buy a stock because you think it’s being taken over. When I recommend a stock, sometimes I say, “hey, this is an attractive takeover candidate.” There are lots of other reasons to buy the stock; that’s just gravy. Don’t ever buy a stock just because you think it’s going to get taken over.

No. 6, develop an information discipline. Learn to identify noise. There’s so much noise out there, there are so many opinions out there. If you’re on Twitter, there’s so much out there. Find the people whose advice you appreciate, whom you respect, and again, somebody doesn’t always have to be right. A lot of times, I read the work of people who I completely disagree with so that it sharpens my thinking. But ignore all the noise out there. It takes a little bit of work to figure out who is noise and who is worth reading.

And lastly, No. 7, stay humble and stay paranoid. Whenever you think you’ve got this game figured out, I promise you, the market is going to put a beating on your butt. I promise that’s going to happen. It’s happened to me every time I start going, “you know, I think I got this. I’m pretty darn good.” That’s when I get my butt kicked. So stay humble, stay paranoid, always be ready for something to go wrong. Always be learning, and if you adhere to these seven rules, I think you’ll do just fine. It takes work. It takes a lot of work. It takes a lot of energy, but it’s fun and it’s worth it, and I think you’ll do great if you follow this work.

All right, my thanks to Steve McDonald, Colleen Hill, Curtis Daniels, all of you for listening. We’ll be back next week with my wrap-up of the J.P. Morgan Healthcare Conference. Until then, I hope your longs go up and your shorts go down. I’m Marc Lichtenfeld.

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