Buying Opportunity in Bonds

Bonds were a lot simpler back in the old days, like last spring. If a company needed to borrow money, it went to the bank and got a loan. If a company needed to borrow a lot of money, it went to an investment bank and issued bonds. But then banks around the world got scared to lend. Healthy companies had to scramble just to make payroll, much less expand their businesses. The stock market tanked and the economy teetered on the brink of a major recession.

Bond maven Dan Fuss, 75, hasn’t come away unscathed. His signature fund, Loomis Sayles Bond, is down 27 percent this year—worse than the average bond fund. Still, the $11 billion fund has returned an average of 5.5 percent a year over the past 10 years, beating the benchmark bond index. As the markets tumbled, Fuss saw attractive investments and started buying, although not as many as he would have liked. He doesn’t think the U.S. financial system will plunge into oblivion, provided the world’s governments take action not just to shore up credit but also currencies. Fuss talked with SmartMoney about what this mess is really about, whether the trillions of dollars governments have thrown at this crisis will help and whether investors can make money from the worst market conditions he has ever seen.

SMARTMONEY: Easy question to start. Did we just have a market crash?

DAN FUSS: Yes, it definitely meets that definition. I go back to 1958, and I haven’t seen anything as bad as this. On the stock side it looks like and feels like the crash of 1974. But we’ve never had the problems in the money markets, bond markets and the banking system like we do now. This is really a panic with no liquidity in the markets. And unlike 1974, this covers the entire world. Sorry, I’m not being very cheerful.

SM: This is a financial crisis because, in part, banks won’t lend money. Don’t they know they can’t make money unless they act like a bank?

DF: It’s a crisis of confidence. I know it’s trite to say, but it’s accurate. They are afraid if they lend money they won’t be able to access it ever again. And no one wants to run out of money.

SM: So that’s it? No more lending? Commence economic meltdown? Adios capitalism?

DF: No, not at all. In the U.S. it’s not even a risk. Our central bank and others are on top of things. The market doesn’t seem to think so, but it is.

SM: Have the feds done enough with the $700 billion rescue package, interest-rate cuts and everything else to stave off a meltdown?

DF: A lot more needs to be done. Actually, no country on its own can lift us out of crisis mode. We’ll need a coordinated effort because so much of the bad debts are spread across the globe. There could be some sort of coordinated action with the 20 largest countries putting a curb on their currencies. The thing that scares the bejeebers out of the market is these currency fluctuations. They’re wreaking havoc with economies around the world. They are making everyone panic, sell everything and run for the safety of the U.S. dollar or the Japanese yen. Putting some sort of curb on it could let the market sort itself out.

SM: This has been a trying time for a lot of people. Is anything good going to come out of this crash and crisis?

DF: It is mostly bad news. There has been a lot of damage done to the financial system, and it’s not good that we knocked out several major broker-dealers like Lehman Brothers and Bear Stearns. There will be some good things, though. I hope there will be a more realistic set of guidelines, rules or regulations. The guidelines we have now just don’t cover the scope of the financial world or leverage. By and large there are very few bad guys in this whole situation. There was some speculative activity that wasn’t good—and hopefully, that will be corralled by regulation.

SM: So you don’t think we should put major curbs on leverage?

DF: Let’s remember that this huge foray into debt actually did some good. This leverage helped the world’s economies grow and improve people’s lives. The tragedy is that the excess leverage didn’t wind down on a more level basis. Both Alan Greenspan and Ben Bernanke said there could be bumps in the road as we unwind all of this debt. But I don’t think they thought we’d be going over one precipice after another. I thought we could have some bumps too, but I certainly had no idea it was going to be this big of a problem.

SM: Anyone turning on a TV knows the U.S. stock markets are down sharply. But what has happened to bond prices?

DF: Treasury bill prices are way up because everyone has panic-sold corporate securities—both stocks and bonds—and bought Treasurys. A one-month Treasury bill is paying a buyer zero interest now, or virtually zero. But the panic has driven corporate bond prices the other way—way down. The difference in yield between corporate bonds and Treasurys has widened out tremendously. Even if you assume that bonds default at the same rate as they did in the Great Depression, and fewer of those defaulted bonds actually recover their value, you will still outperform Treasurys.

SM: Can you give an example?

DF: General Electric. They issue bonds all the time. They are investment-grade. They issued a 30-year bond back in January yielding 5.8 percent. A 30-year Treasury bond issued at the same time yielded 4.1 percent. Now that Treasury bond is yielding 4 percent, and the GE bond is yielding 7.9 percent. The GE bond is selling for 71 cents on the dollar. It’s GE! They’re AAA-rated. That’s crazy. Johnson & Johnson is another example of the wide spreads between corporate and government bonds—and those two are definitely not alone.