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Apple Fiasco Proves That Fixed-Income Could Blow Up

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If Wall Street Journal columnist Rolfe Winkler is right, then investors seeking “safety” could be on the verge of losing billions of dollars.

“Mr. Einhorn’s move might be the clearest signal yet that the bull market in fixed-income and high-yielding securities is well into bubble territory,” writes Winkler.

To me, the fixed-income marketplace appears to be overheating.  There certainly could be more upside, but I see four distinct areas where yields are getting pinched.  Here is a look at yields, asset prices, and of course, Apple’s (NASDAQ: AAPL) potential newest creation (hint: it’s not tech).

Treasury Yield Spread

It starts with the Fed.  The Fed’s quantitative easing program pumped seemingly incalculable amounts of cash into the financial system by way of treasury purchases, which is why we saw treasury prices sky-rocket and yields crater.

Just last summer, for example, non-investment-grade “junk” bonds yielded roughly 7% higher than treasuries.  Not anymore.  Yield-starved investors have swallowed up bonds at a torrid pace, bolstering the bonds’ prices and pushing yields lower.  The yield spread between treasuries and junk bonds is now near 5%, meaning that some fixed-income investors are willing to hold “junk” in exchange for yields under 7%.

For example, simply take a look at Barclays High-Yield Bond ETF (NYSEMKT: JNK).  The ETF closed Tuesday's trading at $40.61, just below its 52-week high of $41.43.  And the trailing twelve month yield?  Just 6.72%.  Look for that yield to drop if money continues to flow into junk bonds.


For another signal that fixed-income is overheating, take a look at the MLP marketplace.  The Alerian MLP ETF (NYSEMKT: AMLP) serves as a good indicator of this sector, because it holds $5.17 billion in assets.  The ETF closed last Friday’s trading at $17, just below its recent all-time high of $17.40.  Here is a look at the current breakdown of assets held by the Alerian ETF.

<img src="/media/images/user_13210/2-9_large.JPG" />

Source: ETFG.com, Institutional ETF Research

The Alerian index has risen 140% since 2008, about twice the increase of the S&P 500.  Likely this is the result of large payouts.  The fund just announced a payout of $.261 per share for the first quarter.  At a price of $17, this indicates a forward 6.14% annual yield if payouts stay steady.  And that is a big if.

The reason is because the sector is attracting major capital flows and high acquisition costs.  Companies have been quick to spin-off some assets in the form of MLPs, because such assets are income-producing and can fetch higher valuations by trading in the marketplace rather than by sitting on a company’s balance sheet.  And investors have been quick to scoop them up. 

Moreover, IPOs have become almost commonplace.  In 2012, for example, new offerings raised a striking $4.75 billion – more than 2010 and 2011 combined

The problem is that the newest IPOs don’t have the asset quality of past IPOs.  Think “tech bubble.”  Instead of high-quality assets like storage and pipelines, as in years past, now some IPOs include less stable and more volatile assets, like refineries and coal.  Small quantities of such asset variations may be okay for a $5 billion ETF like Alerian.  But investors will receive a wake-up call if they find themselves holding smaller funds with the bulk of their dollars in riskier assets.


To illustrate the craze of “The Search for Yield,” just look to the exploits of fund manager David Einhorn.  He is trying to coax Apple into creating a special preferred security that would hold a “senior” claim to Apple’s steady stream of earnings.  He wants Apple to distribute the new security to Apple’s existing shareholders. 

Note that Einhorn is not trying to get his hands on Apple’s $137 billion cash pile by coercing Apple to increase its 2.3% common share dividend.  Rather, Einhorn is trying to create value (for himself and his firm) where none existed before.

Einhorn is hoping that a senior Apple security would command a higher market valuation than Apple’s current 10x next year’s earnings.  If the senior security were to pay out 4% or 5%, then perhaps yield-hungry pension funds and other money managers would flock to it – and thus push up its price to say, 15x or 20x next year’s earnings.  In the end, the original holders of Apple’s common stock would hold an additional fixed-income-like security that had bolstered in price. 

Yields at Any Price

In short, Einhorn is trying to talk Apple into creating a security that satiates the appetites of fixed-income investors.  Einhorn’s actions demonstrate what today’s fixed-income investors desire: high yields at any price.  And that idea is precisely why I believe that the fixed-income markets are a little too hot for comfort.

ChrisMarasco has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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