The Frog and the Bond…

December, 2012

There is a metaphor that if a frog is put into a pot of boiling water, it will quickly realize its peril and frantically jump out.  But (the metaphor continues) if the amphibian is gently placed in a pan of tepid water, and then the temperature is gradually raised, the frog will get used to the warming water and remain in place.  By the time the frog realizes it’s in real hot water, the metaphor concludes, it’s too late and the frog’s goose is cooked, so to say.

We believe the metaphor applies to today’s investing environment.  After a multi-decade rally in bond prices (and the correlating decline in yields), investors today have become inured to the price risk of their holdings as they have become solely focused on current yield.  Earning 3% seems to be enough for many people today, despite the fact that the water is getting warmer.

The current mania for yield is striking when placed in juxtaposition to the mania that gripped markets in the late 1990s.  Then, the mania was for technology, media and telecom (TMT) stocks, evidencing a singular focus on capital gains.  Throughout the late ‘90s and into the ‘00s, many investors were openly disdainful of dividends and other sources of investment income.  Investors were looking to get all their returns from capital appreciation.

That expectation was dashed in the following decade as the TMT stocks fell in price.  Many investors have continued to hold these stocks, looking back to prior price highs as a measure of latent value in their holdings.  Unfortunately, in most cases they are unlikely to ever see those prices again.

Likewise, we feel many folks heavy with income-oriented investments are likely to experience a similar reality.  Though it’s far beyond us to predict the when’s, how’s and how much of the interest rate world, it seems highly improbable that the interest rate rally of the last three decades will be repeated.  As rates begin to retrace their path, many investors will look to their coupon much as equity investors in the ‘00s looked to former stock price highs, hoping that it will preserve their wealth.  In the meantime, they will be ignorant of or willingly blind to the capital depreciation that will erode the value of their savings.

We believe the opportunity going forward – for many years – will be to invest in concentrated equity portfolios that evidence a coherent and economically sensible investment strategy.  We believe that paying attention to the opportunities that avail themselves to the contrarian minded investor offers the highest likelihood of generating returns that are acceptable to the discerning investor.

In other words, we think that remaining in the pan is the wrong strategy in today’s investment environment, and it’s time to start moving out.

The material provided herein has been provided by Linde Hansen & Co. and is for informational purposes only. Linde Hansen & Co. serves as investment adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA. Northern Lights Distributors, LLC and Linde Hansen & Co. are not affiliated entities. 1999-NLD-12/11/2012