What Happens to Bond Prices when Interest Rates Go Up?

When interest rates go up, prices for bonds and bond funds fall and vice versa.  The following examples show the relationship between bond prices and rates.

 

Municipalities and corporations sell bonds for financing.  The issuer who sells the bond pays the buyer interest while the bond is outstanding, and then pays the principal back when the bond is due, that is, when it matures. 

 

The price of the bond is fixed, as far as the issuer is concerned.  If the company sells a $1,000 bond with a 5% interest rate to be paid back in 30 years, the buyer will receive $50 a year in interest, and then receive $1,000 back at the end of 30 years, if he has not sold the bond in the meantime

 

Changes in the Price of Municipal or Corporate Bond

 

If the bondholder keeps the bond to maturity, the changes in price of the bond are not important.  If the bondholder does wish to sell the bond on the open market before maturity, he will have to take into account the price movements.

 

Consider the example above:  if the bondholder elects to sell the bond after five years, he will have to take the price that the market dictates.  If market interest rates have increased in that time, he will find that the price he can sell the bond at has decreased.  It is an inverse relationship. 

 

Why?  If market interest rates are now 6%, no one is going to pay full price for a bond that only yields 5%.  He will have to sell his bond at an appropriate discount, so that the new buyer will achieve the same effective interest rate as he could when buying a new bond. 

 

The opposite situation is also true.  If interest rates go down, the bondholder will find that his bond is now worth more.  New buyers will be willing to pay more, that is, pay a premium, for a bond with a 5% interest rate, when new bonds are only carrying a 4% rate. 

 

The amount of discount or premium depends on the difference in rates and how long until maturity.  Interest rates are different based on whether the bonds are tax free or taxable.

 

Why Changes in Interest Rates Effect Bond Fund Prices

 

Bonds are also held by mutual funds.  Funds can be comprised of only fixed investments like bonds, or can hold both stock and bond instruments.  Since mutual funds can hold many bonds, some of the bonds are likely maturing regularly and are replaced with new bonds.  Bonds in bond funds are also bought and sold, so the mutual fund undergoes the same changes in price as mentioned above. 

 

Since anyone can buy or sell fund shares at the end of each day, bond funds, like other mutual funds, must be priced out every day.    The price of the bond fund depends on how much interest has been earned but not paid out, and the premium or discount that the bonds would require if the bonds were sold that day, whether were actually sold or not. 

 

Bond and bond fund prices move up and down based on the market.  Buying a bond can be a stable investment, but can be subject to the same market forces as stocks if the bondholder wants to sell the bond before maturity. 

Two Days in the Life of Chipotle

I wanted to take a look at the last few days of trading in Chipotle Stock ($CMG) to try to see if I could gain any lessons from moves that at first seem had to understand.  

There is a long term story but I intend to focus on the short term.  I think most everyone who sees this will be aware of the general issues $CMG has had, namely, a very high valuation, falling stock, food and safety issues.  The stock reached $750 dollars in August and then fell to $400 at the peak of the hubbub over e coli concerns.  

Two days ago the stock had recovered to close at $525 on Monday, 2/22/16. The next morning, the stock received a prominent downgrade from Deutsche Bank analyst Karen Short (love the name) about the same issues that had been dogging the company.  The downgrade was to sell with a price target of $400.

OK, a major Wall Street name (should Deutsche really be from Wall Street?) downgrades, you would expect the stock to drop.  And bang, on Tuesday it did to $511 or so premarket.  Then it opened a bit higher than that, but still down.  Then, all day it started to rise and lo and behold, but the end of the day it was actually went “green” as they say, higher than it started.  It ends the day at $525 again.  The downgrade was, like, completely forgotten.  What the hell?

On Wednesday, the whole market craters when oil goes down, and Chipotle goes back to $512, and when the market reverses like a steamroller $CMG does like, nothing.  It ends at $514.  A roller coaster ride with nobody at the controls.  Or at least that’s the way it seems.

Now, these $10 moves seem pretty big, but they are only 2% moves because of the high share price.  Still, a 2% move day after day is substantial. 

I’m trying to understand.  Why does the downgrade impact share prices for maybe an hour?  There are some who believe that ratings changes are sinister, and that a downgrade is done in order to lower the share price so that the big boys can buy it cheaper (and the opposite for an upgrade so that the smart money can get out at a higher price.)  The conspiracy theorists would add that the large players knew the downgrade was coming so they could sell before it was announced. 

I don’t know whether to believe this, I like to think I am not that cynical.  But otherwise, I am at a loss to know why $CMG moved like this.  It just reinforces my belief that trading intraday moves is just gambling, and there’s little logic to it.   Others may have different ideas.  

Disclosure, I do have a option position on $CMG, looking for it stay near its current price.  

Don’t Wait to Begin Investing

Thomas Bruni @BruniCharting  had a excellent tweet on the difference between investing and trading:

“As a trader/analyst I don't like equities.

As an investor, I'm buying stocks next week, month, year, decade, etc. Know your timeframe/goals”

I started thinking about some of the reasons why people delay investing.  I ran the numbers on what happens if you delay investing because you don’t like the market.

Let’s take a 30 year time frame.   A $4,000 annual investment at a modest 6% return awards you with $339,206 at the end of 30 years. 

If you don’t like this market and spend the money this year money instead of investing it, your payout drops to $316,232.  Postpone investing by five years?  Now your nest egg is down to $236,625.  Spending $20,000 now costs you $100,000 down the road. 

But you don’t the market?  You think maybe a bear market is coming next year?  It doesn’t matter.  If you put your $4,000 in the market and the market drops 20% this year, your fund is worth $333,572 after 30 years.  The 6% annual increase over 29 years more than makes up for one bad year now.

Hey, it’s your money, use it however makes you happy.  But I think you’ll be a lot happier if you have more of it to throw around later when you need it.

Time to go bullish

I don't know about capitulation, overaold conditions or moving averages, but i know when stocks stop going down..  That was today.

I turned bullish this afternoon when the market started to recover.  Shorted some $UVXY and bought a put on $SQQQ which is the Bear ETF for the 3X SPY.

People are way too bearish after the bad start to the year.

I'm Bearish Here

If you've got some money you are going to need in the next few months, or are a short term trader, you probably want to consider pulling it out of the market.

If, on the other hand, you've have money in a 401K with a 20 year horizon, you'd be better served to just wait it out and add more if the market goes down.  20 years is a very long time as far as investments go.  Think back to 1996. Could you have come close to predicting what was going to happen over the next 20 years then?

Big Comeback in Stocks Today - Is it a Good Sign?

The stock market come back big from being down even bigger.  A lot of talk that this is a positive sign for the market, so I wanted to test it.

The $SPY finished just under 2.% off the lows today, so I ran a sample of days where the index finished 1.8% or better above the low for the day.  You could dice it a lot of ways, but this is the one I chose.

It's happened a lot of the last 15 years,  I looked at what happened the following day or days and didn't really see a major trend.  Some days were up, some down and some barely moved.  In looking at the list, I saw it happening a lot in 2008, a very bad year for stocks.  So, I added up the numbers per year.

2015	3
2014	3
2013	2
2012	6
2011	21
2010	13
2009	40
2008	61
2007	7
2006	2
2005	1
2004	2
2003	23
2002	49
2001	40
2000	37
1999	20
1998	27
1997	24
1996	10
1995	2
1994	3

As you can see, the worst years are bear market years, 2008-9 and 2000-2002.  Having a lot of these is a sign of volatility and a bad thing. I can't say what one day will bring, but a lot of them are not good. 

Best of luck trading. 

Why I am short gold today

I sold off all of my money in equities today. Not that I am particularly bearish going into tomorrow’s Fed meeting, just that I don’t have a good feel for what may come out of the meeting.  I expect I will be buying back in after a few days, once things settle down.

The one thing I did keep is a short position in the Miners, Junior Miners and in Silver, via the 3x ETFs.  The reasoning, such as it is, is that the general consensus is that the Fed will be dovish when it announces tomorrow.  I judge this on the fact that gold and silver have exploded to the upside this week.

The strategy is no matter what the Fed announces, good things happen.

·         If they are dovish as expected, then nothing much will happen.  I should get the benefit of those ETFs going down through the daily rebalancing, or through a small selloff.

·         If they are a bit more hawkish, I expect Gold will sell off big time, dragging the miners down with it.

I see it as a win/win, or at least a win/not lose.  It’s the concept of going against a crowded trade. 

I’ll know tomorrow if it works.  If I don’t get shaken out before that.

Where are the Customers on the Forbes’ Billionaires List?

The Forbes list of billionaires is out for 2015 and Michelle Celarier @mcelarier tweeted that there were 38 hedge fund managers on the list, led by Ray Dalio at $15.2 million. 

I posed a question to Michelle, “Where are the Customers on the list?” and she responded that, indeed they were on there, as many billionaires would be clients of the hedge funds.

And I suppose that’s true.

But, the hedge fund managers had achieved the list because they ran hedge funds.  The customers made it because they earned or inherited the money from other endeavors, not because they invested their money in hedge funds.  

I just wonder how many customers made the list in spite of investing with the hedgies rather than because of them.

  

Does the $UVXY decay over the weekend?

Someone on Stocktwits made a comment that you should never hold the $UVXY over the weekend because you loose (sic) 2% due to decay.  I ran the numbers going back to when the UVXY was established to check that statement.

The UVXY is the Proshares Ultra Short term VIX futures ETF, which is a measure of volatility in the SPY futures times two.  This ETF was created in 2011.  Since its inception, it has declined in price by close to 98%, due to its design.   The question is whether this occurs over a weekend. 

The results?  The UVXY moves a lot over the weekend, but there is no clear trend.  Actually, the net change from Friday close to open Monday averages out to almost nothing.  Some weeks it moves up, some down, but overall, it is almost exactly zero (0.12%). 

Most of the move in $UVXY happens intraday, not over night.  Personally, I don’t ever recommend holding this ETF because of the decay mentioned.  But it’s not about the weekend.

This post is not a recommendation to buy or sell any investment.  Disclosure: as of posting date I have no position in $UVXY, but I often buy and sell and may at any time. 

It's Not Easy

I am big fan of Stocktwits, I uncover a tremendous amount of great information there, and I get a many good ideas of the traders, investors and generally good people.

That said, let me rant just a bit:

 I bristle when anyone says making money via any particular trade is easy, or simple, or a no-brainer (at least unless maybe it is coming from Carl Icahn.)  Nothing about the market is easy and even if the person gets the trade right, it’s not because it was easy.

If I see someone call a trade easy, I figure they are arrogant, a newbie, or both.  Experienced and savvy traders don’t call anything about the market simple.  

The Bull Market is Intact!

Sorry for the hyperbole in the title.  Neither I, nor anyone else knows if the bull market will continue another day.   This post is a follow up to one I wrote on the weekend.  In that one, I looked at the $VXX performance after it had gone up by 15% over three days. 

For the last three years, every time the $VXX met that criteria, it dropped back on the fourth day.  Nine out of nine.

What does that have to do with the bull market?  In a discussion on Stocktwits, another member @allgoodtrades remarked that we were in a bull market, and the $VXX wouldn’t continue to spike like it did in 2011.

And lo and behold, what happened on August 4th?  The $VXX did drop, a substantial amount, actually. Ten out of ten now.  Leading me to conclude the bull market is intact, the SVXX should keep dropping and all is right with the world. 

OK, that’s a stretch, and I intend to remain cautious. But from this indicator, I see no reason not be optimistic, or upbeat, about the market.

   

Nothing in this post is meant to be a solicitation to buy or sell any security.  

It Works until it Doesn’t

I recently owned some $VXX puts and sold them on Friday.  It was a sort of continuing trade over the last few weeks of puts and short positions which I finally closed out.

$VXX is the iPath S&P 500 VIX short term ETN.  The VIX is a measure of volatility in the market.  Simplistically, the VIX generally goes up when the overall market is falling, and vice versa.   

In response to an inquiry, I had a civil discussion with @allgoodtrades (Gavin) on Stocktwits about where the $VXX was going next.  He thought it would fall, and I was concerned about it spiking higher if there was a correction (crash) on Monday, August 4^th.  I was staying on the sidelines.

Gavin challenged me to look at the chart and find another time in the last three years where $VXX rose as much as it did in the last three days.  It’s very hard to see that in a chart, so I ran the historical prices in Yahoo! Finance.

Over the three days ending 8/1/14, $VXX went up 15%.  In running the numbers, I found nine times where the $VXX went up 15% or more over the last three years, actually a little less than three years, more on that later.

Although this wasn’t as unusual as Gavin thought, I did something interesting.  In each of the nine times the ETN ramped over a three day period, in closed lower on the fourth day.  Nine out of nine.  It’s hard to beat those odds.

The VIX in 2011

Unless you go back the full three years.  In August 2011, the $VXX had a spike that kept on going.  Check out the closing prices from that period.

8/22/2011	43.86
8/19/2011	42.55
8/18/2011	40.47
8/17/2011	33.53
8/16/2011	32.87
8/15/2011	32.18
8/12/2011	34.13
8/11/2011	33.78
8/10/2011	35.17
8/9/2011	31.26
8/8/2011	34.78
8/5/2011	30.31
8/4/2011	28.89
8/3/2011	24.08
8/2/2011	23.97
8/1/2011	22.41

So, which do you believe?  Nine out of nine times during a great bull market, or the one time when it looked bad for equities?  Do you think the market we have now is the same as the last three years, or are we in for the rough ride like we had in 2011? 

Honestly, I don’t know, but the risk is pretty great, and for me, worth watching from the sidelines. The point is that if you find something that works every time, it’s still not guaranteed to work the next time.  The situation may be different.  It works until it doesn't.

And by the way, the $VXX wasn't around in 2008, but you imagine what would have happened to $VXX or it's more leveraged cousin $UVXY when the market really crashed

Good luck.  We’ll know shortly.  Nothing in this post is a solicitation to buy or sell securities.    

My Investor’s Toolkit

I am not really a technical trader, although I do think there is some benefit to watching the moving averages.  I just think the rest of TA is overdone. 

I am looking for an edge, either the best ideas or news that will allow me to be more proactive.  So, my toolkit is mostly bloggers and news providers.

Listed in the order that I generally use them.

Twitter – I follow all the big name traders, you know, the Fast Money guys, JC Parets, Jon Boorman.  Mostly professionals in the stock biz.  Also TV people like Becky, Maria, Mandy, Trish, Jane… well, you get the idea. 

Stocktwits – I have people I follow, generally not those that I follow on Twitter.  These are mostly amateurs, or hobbyists.  It’s more of a social thing  You can see who I follow there if you click on my name.

CNBC.com – Generally business news and stock quotes.  Works best on my phone, an HTC One, which I don’t recommend. 

Yahoo Finance – More news and quotes.  I also like their charts, which allow you to compare multiple symbols, and are easy for a non-chart guy like me to follow.  I also use the historical price function which allows me to download daily prices to excel and manipulate them.  Did you know it is better to buy Apple on Monday vs. Friday, over time?  I don’t know if that knowledge is worth all that much, though.

There are a few bloggers I follow when I can.  I usually see the entries when they post a link on Twitter, but these I will actually look up:

thereformedbroker.com – Josh Brown

ritholtz.com – Barry Ritholtz

crossingwallstreet.com – Eddy Elfenbein

I don’t care for Business Insider because it’s a bandwidth hog.  I will sometimes read the articles. 

I don’t watch much business TV any more.  If I can, Fast Money and once n a while that Cramer guy. 

Props to 1nvestor for the inspiration

Why I Post my Trades on Stocktwits

Stocktwits is a site founded by Howard Lindzon that allows just about anyone to comment on most publicly traded stocks.  Many people use it to ask questions, share their opinions, or plug their newsletters or websites.   I like to post my trades there, with entrances and exits.

I started with the goal of posting all my trades, but have decided I don’t have the time, or the interest in sharing every detail of my trading.  Still, I do find it helpful to share not only what I am thinking at a given moment, but also the actions I have taken.  I may post what I buy, and I try to give an idea of the price I paid or sold at, and a vague I idea of the size of the trade.  One thing I don’t do is give the number of shares or options.  How much I invest is really only my business.

Why do I share this? OK, first, this is NOT why I post my trades:

1.  I don’t post to gloat on my winners.  Investing is really difficult, and no one needs to know how smart I am, or that I pretend to be.  If I see someone gloating, it’s a real turn-off.
2. I don’t post to sell anything, because I am not selling anything.  No newsletters, websites, or books.  Yet.  You can’t buy my ideas on stock trades, because they aren’t for sale.  I don’t know that anyone would pay for them anyway.

So, why do I share them?

1. Someone may get some benefit, or education.  I have gotten nice notes from people who did say they learned something from what I am doing, usually from a follow up question.  I have gotten some nice (and some not so nice) responses from people who take the other side.  That’s OK, it’s what makes a market.
2. The biggest reason I post is that it keeps me honest with myself.  If I know that I will be sharing my trades, it is a lot harder to take a risky, unjustified position (a “flyer”).  Like buying options before an earnings report, or shorting a momentum stock.  I may still do these dumb things, but if I plan to expose my thinking to the world, I would like there to actually be some thought to expose. 

Best of luck trading.  Nothing here is a solicitation to buy or sell securities.  

The Big Mistake I Made in 1999

The 1995 to 1999 period in the stock market was known as the dot com era, when the internet exploded and money poured in many stocks which had no profits, little revenue and depended on "eyeballs" as a metric.

As a young (well, younger) investor at the time, my main interest early on was building a retirement nest egg and making a fair return on my available cash, which wasn't all that much.  I had been trained to think of investing in good companies that paid a safe dividend.

It was a good strategy, and early on, I did pretty well, swelling my meager retirement account into a nice bundle and making a few bucks for play money.

Scansoft 

Then one day, my boss at the time, introduced me to a bit more risk.  He gave some advice on a company named Scansoft.  I didn't know what they did then, and don't now.  But in few days, I made $1,000, a 20% return.  You would think I was hooked, but ah, I wasn't.  My training told me this wasn't right.  So, I backed off, and returned to safe investing.

All the while watching everyone making huge gains on stocks that no one thought had any value.  Names like Vertical Net and PSI Net are ingrained in my memory. Huge valuations with no sustainable business model.

Echelon

Then there was one called Echelon that was particularly annoying.  Someone I knew knew someone was had researched the company, and they had a real product.  The stock started at 3 and came to my attention at 6.  I bought it at $13, it went to 30, and I bailed, convinced that it didn't belong there and would come crashing down.

Of course, it finally hit 100 before it crashed.  I don't know if it's still around and I don't care.

My Big Mistake

My mistake, as it turns out was NOT getting caught up in the fever and ridiculous valuations.  If I had, I would have made a lot of money, and could have gotten conservative nearer the top, or after it had been reached.

I see this a lot now.  Some people have been fighting this bull market all the way up.  I try not to, despite my conservative nature.  Bring it on.  I hope to have enough time to bail on the downslope rather than the way up.

Please, please, do your own due diligence, and don't take anything I say as an offer to buy or sell securities.  Look at my track record.

My Best Advice for Stock Market Traders

I consider myself an investor, not really a trader, but like a lot of people, I do think I pick a winning trade from time to time.  Unfortunately, since my funds are limited, like everyone, it leads me to sell stocks in order to buy new ones. 

This leads to my worst performance.  I always think that my current holding is not going to as good as my next one.  I sell what I have to chase something else.  Generally, this is usually a bad move.  The stock used to own does just as well or better than the new one I bought. 

Add to that fact that in the process I paid commissions to go in and out of the two positions.  That’s just dumb. 

Comparison to Baseball

I’m a baseball fan, and if there’s one thing I don’t like to see in baseball, it’s overmanaging, particularly when a manager changes relievers repeatedly, multiple times in an inning.  As if the next pitcher is guaranteed to get next guy out.  Like the next pitcher is going to be better than the one that is already in there. 

Sometimes he does the job, sometimes he doesn’t.  In baseball, there’s no way to know how the other guy would have done.  In stocks, we do know.  They continue to trade even if we don’t own them. 

So, a little advice:  STOP TRADING SO MUCH.  Review not only your past trades, but what happens to stocks after you sell them.  You will likely find that you would have been just as well off, or better even with commissions, as if you just held the first stock.

If you feel you have to trade just to do something, then you have another problem.  You aren’t trying to make money; you are trying to fill some other need.  If so, just expect to continue to underperform.  Nothing is going to help that. 

Where's the Stock Market Crash?

If you follow the stock market pundits, you know that many of them have been calling, or at least warning of a crash for some time now. So, you have to wonder, where is it?

I mean, it's been years now. Some of my favorites have been calling for a 50 percent fall for so long the market would have to fall 50 just to get back to the level where they first made the call.

Now, anything is possible, and I dont know the future, but neither does anyone else. Generally, the market doesnt make big moves. Only rarely is there more than a 5 percent move in a month's time.  You have a better chance of losing 5 percent by moving your money in and out than having the market take a tumble.

So, my advice is, every time you feel like making a trade, do something else. I won't suggest to you what, but anything. Get a candy bar. Watch a movie. Et cetera. If you still feel like making a move later, make a smaller one than you planned.

And if think Pundits have the answers, read Macke and Brown's book, Clash of the Financial Pundits.

Why is the Stock Market so High?

The stock market, as measured by the Dow Jones and SP 500, closed at another record high today.  That causes many people to ask:  Why is the market at all time highs?  Is it overvalued? Will it crash soon?

As to the first question, there is some debate as to whether the market is high.  Yes, it is, in dollar terms, higher than it ever has been.  But, if you take into account inflation, it isn’t as high in “inflation-adjusted” terms as it was a few times in the past. 

More importantly, there isn’t really a perfect measure of what “high” means.  It is only in terms of price, or a percentage of what companies earn (the P/E ratio).  Or you can look at the P/E over the last 10 years (CAPE ratio.)  You can find justification for just about any position you want.  

The Stock Market is High

If you accept that it is high based on the price, there are possible explanations.  I prefer the simple supply and demand explanation.  In basic economics, when there is more supply for a good, the price drops, and vice versa.  When demand for a product goes up, the price goes up. 

Right now, there is a bit of reduction in supply because companies are going private, fewer companies are going public, and public companies are buying back shares at an increased rate. 

I tend to think the big difference relates to increased demand for stocks because of low interest rates.  If an investor has money to put to work, his options are limited.  He can only get 2.6% on a ten year bond.  Other options, like real estate or gold, are less liquid.  That is, harder to get money out in a short time. 

Therefore, more money is pouring into stocks, many of which pay a dividend, and have recently gone up. 

So, why is the stock market high?  Because like Richard Gere in An Officer and a Gentleman, “(it’s) got no place else to go. “

As always, nothing here is meant to be a recommendation to buy or sell securities. 

Compound Interest, Die Hard and Hans Gruber

Die Hard is a spectacularly entertaining movie and can be used as a lesson in compound interest.

Spoilers follow.

The villain, Hans Gruber, played marvelously by Alan Rickman, attempts to steal $600 million dollars and plans his escape so that he can retire to an island and earn 20%.

Now, even in those days, earning 20% wasn't easy, and it seems less likely now.  But, taking him at his word, he was very smart financially.  His plans are something everybody can sensibly aspire to.

The movie was made in 1988.  If he had been able to accomplish the two things:

1. Steal $600 million
2. Earn 20%

and hadn't had to touch the money,

he would, through the magic of compound interest, now have a fortune worth

$57,237,729,986.44

That's $57 billion and change, which would make him 5th on Forbes' list of world's richest people

Not bad. .

A Fable on Stock Market Valuation

Why valuation is a lousy measure.

King Midas gave up the gold thing, and bought all the outstanding float of $KMID.  Midas owned 1,000,000 shares of the stock, and on the day he bought the last share, he paid $100.  Therefore, the closing price of the stock gave him a market cap of $100 million.  That’s one hundred million dollars.

Now Little Johnny tended the King’s gardens and prevailed upon him to sell him a share of $KMID.  Believing it was undervalued he offered the King $110 for that share.  The King was an evil man, so happily took the money at the bid.  He was amazed to find out his value in the company had risen to $10,999,890.  And he had 110 bucks cash to show for it. 

When Johnny’s mother found out that he had blown the family grocery money, he forced him to return to Midas to sell the stock back.  The evil Midas agreed, but at the price of $105.  With no alternative, Johnny took the price, poorer but wiser. 

King Midas had all his stock back, $5 in his pocket, and a new market valuation of $10,500,000.  The stock caught the attention of the Wall Street pundits and trend followers. But, of course nothing about the company or the stock really changed.  

Farfetched?   I suppose.  It would take a lot of dumb, evil people make something like this happen in the real stock market.

Oh, yeah.   Think about that the next time you invest in a stock simply because the price changes.