I’m not one of those bond bubble guys, mainly because I see eerie parallels between the Japanese experience and what the US is currently going through, but there is some crazy stuff going on in bond land. Late last week Microsoft (MSFT) sold 5 yr bonds at a yield of less than 1%, 0.993% to be exact. This set a record for the lowest yielding 5 yr corporate bond offering ever. The first thing I said to myself was ‘whoever is buying these bonds is nuts?’ Lets look at the details and see what simple alternatives an income investor has.
The details of the MSFT bond offering are, more here:
Microsoft (MSFT), one of the last remaining U.S. companies with triple-A credit ratings, sold $2.25 billion of bonds, including $600 million of five-year bonds that yielded 0.993%. That marks the lowest-ever yield for a five-year corporate bond deal, according to Standard & Poor’s Leveraged Commentary & Data, besting the 1.06% yield on a Bristol-Myers Squibb (BMY) five-year bond sale on July 30, when underlying Treasury-bond yields were at record-low levels.
OK, 5 year bonds at less than 1% per year. First, lets hope whoever is buying these things is a tax free investor like a pension fund. But still, with inflation running at about 2% year as a conservative estimate you’re starting out losing with a good chance to lose money right away. So, these investors must think yields will go down and inflation will go down. Possible but doesn’t seem like a high probability bet to me. Pretty crazy. And as an income investor there are a lot better opportunities out there.
Lets say, like these bond investors, you love MSFT’s AAA balance sheet and would like to invest in it. You could always buy the stock, priced at about $30, with a 3% yield with prospects for at least 10% dividend growth going forward. This seems like a much better deal to me, 13% a year potential returns vs 1%. But lets say that’s way to much risk for you, you fear the stock going down a lot. OK. so what about selling some puts on MSFT stock to generate some income?
In general, I don’t think this is a great environment to sell puts on stocks with volatility so low. But here we are comparing with a specific bond offering. In MSFT options you can go all the way out to 2 years and sell some LEAPS (fancy name for long term options) at pretty decent prices. Here are the Jan 15 PUT LEAP quotes from this morning.
For example, you could sell Jan 15 $20 puts for $1.67. That’s a yield of over 8% over 2 years, or about 4% per year. That’s 4 times the yield on the MSFT bonds! The risk? The risk is that you would be forced to buy MSFT stock at $20. That’s about 33% lower than it is today and would represent historically low valuations. In my opinion, that’s a great risk/reward ration and a hell of a lot better than earning 1% a year on MSFT bonds. Or how about not doing anything and waiting for better values? If the opportunity cost is only 1% a year sitting on the sidelines is not such a bad idea.
In short, this record offering of MSFT 5 year bonds at a yield of less than 1% per year seems like at least one example of a very frothy corporate bond market.