Buy-and-hold strategy no longer works for bonds

New era of uncertainty for corporate debentures


February 06, 2000|By Gail MarksJarvis | Gail MarksJarvis,KNIGHT RIDDER/TRIBUNE

There was a time when the American icon of the life of leisure was a gentleman so well-situated that he simply spent his days lounging around clipping bond coupons.

But a new era has come along to change the formerly easy life of corporate bond investors, whether they're rich or of moderate means.

"Gone are the days when you just buy a bond and hold it," says Mark Simenstad, Lutheran Brotherhood portfolio manager. "Even the old stalwarts can get hurt very fast."

Consider some of the household names that have recently been battered: J. C. Penney, Saks, Waste Management, Lockheed, Safeco and Levi Strauss.

In a year-end bond report by Morgan Stanley Dean Witter, analyst Clive Parry notes that despite their stellar names, the bonds' credit quality has slipped so far that prices have plummeted. The bonds now rank among what he calls the "Dirty Thirty."

Corporate bonds, like treasuries and municipal bonds, were hurt in 1999 by rising interest rates. But beyond the interest rate drag on bonds in general, the fast pace of technological change and the mind-set of stock investors has also weighed down some corporate bonds.

In the "new era" of stocks, investors reward companies that grow quickly and are in the forefront of technological change, while they shun bricks-and-mortar stocks. Solid companies -- particularly retailers -- face an added threat from upstarts now selling to consumers over the Internet.

"J. C. Penney used to be a hallmark of corporate credit," notes Simenstad. "Now, the stock's off 50 percent, and the bonds are trading very weak -- almost like junk bonds."

J. C. Penney's problems aren't entirely new or "new era" oriented. Investors have been unenthusiastic about the company's stock since 1995. But Simenstad says that as new Internet retailers take away sales from old retailers, J. C. Penney and other old-style retailers face an extra hurdle that is putting pressure on corporate profits and consequently dragging bond prices down.

"There are some fears of defaults among retail names," Simenstad says. In part because of Internet competition, retailers cannot increase profits by raising prices.

Bond prices fall when investors believe a company will be in a weaker position to repay bondholders.

Levi, for example, used to be one of the hottest jeans makers. But when the company missed a major marketing movement and teens no longer thought the jeans cool, the company's growth was short-circuited. That was only one of its problems. While Levi ignored industry changes, the company also took on a lot of debt.

Now, notes Simenstad, the company has loans that are maturing and must be refinanced. With banks leery about the company and interest rates rising in general, the company's cost of borrowing money will be high. That will make it increasingly difficult for the company to increase profits.

Corporate bond investors have always had to be on the lookout for companies that take on substantial debt and then confront declines in sales or earnings growth. Simenstad thinks the new era adds extra pressure because stock investors quickly lose patience with a company that encounters even a short-term setback.

Consequently, the new era is no environment for individual investors to buy corporate bonds if they prefer to sit back and figuratively clip coupons without baby-sitting the companies that issued them.

Investors who want a life of leisure might be wiser to buy U.S. Treasuries or a low-expense bond fund that has a manager to do the worrying. Or if individual corporations remain appealing, consider short-term bonds that will mature within two or three years.

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