Updated: Aug 16, 2022
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In this edition of the Redfish 411, we're talking about Bonds and what I'm expect to see in the news.
The markets just closed for the day closed down about 55 points but we are still the S&P 500’s in record territory as you know on the 411 what I try to do is bring about a particular topic just to let you know what I'm thinking about when it comes to the markets and kind of what I think is going on out there give a little background give a little flavor if you will to the markets as well as try to use this for education and so I did want to talk to you guys today about bonds and what I'm seeing in the bond market and what I think you should expect to see in the news now bonds ordinarily it's more fun to talk about stocks but one of the basic things that I tend to spend a lot of time teaching is how the bond market works what makes the bond market work
I think if you can get a grasp on what makes the bond market work you can then better have an idea of what is making all of the overall markets tick So what I want to do is just spend a few minutes talking about bond basics that will lead me into the conversation which is what is in the news today and what has some people fearful about the stock market which is called the big bond taper or bond tapering and we're going to get into that so real quick I'm going to give you a little 101 if you will on the bond markets so how a bond works a bond is simply a piece of paper many of you have had bonds before you've had CDs before you've heard of treasury bonds it's just a piece of paper that represents an amount of money so from my examples and for most bonds the amount of money that one bond represents is $1000 so one bond is $1000
The way that it works is you give $1000 to the government the company to whomever they give you a piece of paper which is their word or their bond between you that says I'm going to hold onto your $1000 for X amount of time the maturity let's just pretend five years I'm going to hold it for five years and for me to hold your money for five years I'll pay you 5% interest a year on that $1000 for five years and at the end of five years I'm going to give you your $1000 back you're going to give me back my piece of paper and we both walk away happy so all different companies utilize bonds or the local government utilizes bonds you have these you hear about bond issues all the time that is how people raise money is they issue a bond with a simple interest rate on it for a specified amount of time you can have one week bonds you can have a 30 year bond you could have a 50 year bond I've seen some court so the but the point being there's all different time frames and all bonds act similarly like if I could say the word similar but a little bit different.
So what are some of the differences the first thing is difference in a bond that I think you've got to pay attention to is who is behind the bond that's known as the issuer who is the issuer of the bond. I'm going to make up a scenario for you the scenario that I'm going to use is let's use a big local company let's use Exxon Mobil and let's use Bob's pencil shop this is the one that I used to use and all my little seminars that I used to give but I would choose somebody in the audience say you're going to open up a company what do you want to do we would make up a company on the spot yeah it made it more fun I think it made it more fun so left pretend that you've got $10,000 and you want to buy a bond and Exxon says OK I will give you my bond I will pay you 3% interest for ten years and then I will give you your $10,000 back so that's how that Exxon bond would work so it's a 10 year bond $1000 per bond you're buying ten of them $10,000 it's backed by Exxon after 10 years excellent gives you back their bond their piece of paper their word their agreement and in the meantime you collected 3% interest OK not bad that was the deal but then on the other side of the equation you've got Bob's pencil shop and there's a guy named Bob and he just thinks that pencils are going to be the next the next wave that people are going to have to have at their business desk and so but he needs startup capital and so you're sitting down and you've got the Exxon bond paying you 3% and Bob says will find I tell you what I write you a bond you give me $10,000 I'll give you 3% for ten years too OK so we have an Exxon bond and we have Bob's pencil shop bond both paying me 3% which one do you trust to get your money back and make all of those 3% payments do you trust Exxon more than you trust bobs pencil shop or do you trust bobs pencil shop more than you trust Exxon well this is obviously you trust Exxon more so X if Exxon is paying you 3% you go back to Bob and say look dude you're a brand new car excellent been around forever I don't think they're going anyplace you're going to have to pay me more than 3% he says fine I'll pay you for you say no thank you five no thanks until you come to where the market thinks it can go so Bob might have to pay you 20% so now you're going OK I can give a bond to Exxon Robert again 3% or I can give it to Bob's pencil shop or I can get 20% per year or $2000 a year so you literally more than double your money but that's what it takes so the higher the risk usually the greater the yield needs to be so in essence that's how that works.
Now let's talk about interest rates what has to do with these bonds let's go back to our Exxon bond and you've got 10 years to maturity and they're paying you 3% or what happens if interest rates in the United States of America start to go up if interest rates go up you can buy a similar bond to the Exxon bond that's paying silver sent they might be have the same credit worthiness as Exxon so let's just pretend it's world that shell just to make this conversation easy so you've got a Royal Dutch Shell bond at an Exxon bond both with the same maturity but one is paying you 4% the others paying you three which bond do you think is worth more obviously that 4% so as interest rates go up it actually damages the value of the Exxon bond so if interest rates are going ah bonds are not the place to have your money because their value even though you're going to get your money back if they stay in business you get your money back at $1000 per bond but throughout that 10 years the price that bond is going to vary wildly let's say hey I need to sell this bond I need that I need my $10,000 back and they'll say OK we'll pay you $900 per bond well wait a minute I paid $1000 but it's not worth $1000 today at maturity it'll be worth $1000 but today with nine years left or eight years left it's worth 900 why is it worth less because interest rates went up so as interest rates go up the price and the value of bonds go down just as we've come out of an environment where interest rates are going down.
So if you were holding onto a government bond or an Exxon bond a CD that was paying you 7% and you go out to the market and you can only get one or 2% or even a half a percent people are willing to pay you more for that 7% piece of paper that your own and right they so it's very important to realize how interest rates affect bonds.
I'm going to now segue into who was the largest bondholder in the world or bond issuer excuse me in the world it is the United States government the United States government issues more bonds than anyone is not even close so we tend to look at treasury bonds as the as the method if you will to gauge how all other markets are doing so you could buy a two year treasury note or a 30 year treasury bond just to keep things easy let's just concentrate on the 30 year bond So what we have here is a government bond that is constantly issuing new that's the debt you here talking about that's the debt that's all the debt that's out there that we owe are in these bonds so they're issuing debt and they're issuing debt so if you're issuing debt every month the rate is going to change so there's all sorts of different rates and all sorts of different maturities on these bonds the people who are in charge of interest rates are the Federal Reserve board so one of the things one of the tools and the toolbox of the Fed to control the economy is whether or not they are buying back more of their bonds or not.
When COVID came about The Fed got together and said OK we need to keep interest rates really really low yeah we're going to do is start buying our own bonds back so if you held a bond they would say hey we're going to buy it back four here's the price and they would give you a price that was probably better than what you bought at because they're calling it away so it's called a call So what they're basically doing is they're buying these bonds back the Fed has been buying bonds back to the tune of about $120 billion per month since Covid started I want you to think about that number 120 that's 40 billion word in treasuries and I mean 80 billion of treasuries and about 40 billion up to 120 of mortgage backed securities so 80 and 20 was kind of the breakdown of how they were doing that and so it's a tremendous amount of money so member we're talking about when rates are low and keep him loathe values of bonds are high the fed's buying there keeping rates low in keeping the value high by buying.
What happens when the Fed stops buying supply and demand most likely you would expect yields to rise when the biggest buyer on the block says I'm not going to buy as much we actually have an example of this happening I want you to go back kind of in your head to 2013 so in 2013 we're coming after under throws of a UM reception a very deep recession.
You remember that we had wasn't all that long ago and so fed chairman at the time was a guy named Bernanke and Bernanke in May of 2013 is giving a speech and he says you know what we're doing the speech he just says this we're going to start buying less bonds back that became known as tapering the amount of bonds we're going to buy there's a market immediately reacted in fact the S&P 500 and in May of 2013 dipped 6% and I mean it was fast and of stock market correction scares people keep in mind that people have a long memory now granted you know the stocks ended up closing up that year I think close a 30% after that after from that low of once it corrected it went up another 30 but the markets reacted poorly to that so recently the Fed has been hinting at you know our guys I think we're going to start to taper well what do you think many commentators are doing here comes inflation hit by gold it's happening now and their hair is on fire.
There's a big difference between what we came out of in 2013 versus where we are today there's a big difference economically speaking we are coming out of a recession that was due to COVID not underlying market fundamentals it was due to COVID which shut it down also what's different is the Fed is telling us what they're going to do Bernanke gave no warning in 2013 he just said it in a speech boom here it is deal with it I think lessons have been learned and they're going we should probably start to talk about this so last week this week they started talking about tapering and they said that towards the end of 2022 we may start to taper a little bit in other words we're not going to hit the brakes because we think there's so much inflation in the market but we're going to slowly take our foot off the gas I think what you will see is interest rates will start to go up not tomorrow not next week not but in 2022 we're going to start to see that the interest rates could possibly start to go up.
Have you've heard me stay in person as you've seen me write in emails and as you've heard me stay say on this podcast I happen to think that rising interest rates are a sign of a healthy economy not out of control inflation but slowly and deliberately rising interest rates are a good thing and I think that's what the Fed is showing they're saying guys this market looks good and I've had a lot of conversations over the past really few weeks in there are still a lot of people who are incredibly nervous about what's going on in the world which I understand they're saying this delta variant with COVID they're getting nervous or and I am still sticking to my guns that everything from an economic perspective is still really good we are seeing this in the earnings of the companies who are reporting there were porting that were going on through earnings season these companies are reporting earnings in there beating the estimates in other words they're earning more money per share then most analysts thought they were going to and in the post earnings period when the CEOs and CFO's are going to the microphone and there discussing the previous quarter the analysts are asking what about going forward and they're each saying it looks pretty good that we may have to raise estimates on where we think earnings are going to come in we think our margins are going to continue to improve if margins are improving that just means that your profits or getting higher and it looks like that's happening.
The other thing that I encourage everyone that I speak with go talk to local business owners ask them yourself how's business look today how does it look going forward versus how it looked not too long ago and I think you going to hear the same thing it looks pretty doggone good and that's what we're hearing on Wall Street that's why I continue to be as bullish as I am on the markets as I happen to think we're in a very good environment for stocks to proceed to go forward again I always add the caveat there could be a correction and I strongly feel like we could see a 5 percenter which is going to look real scary but for those of you who I've been talking to you know the worst going to take advantage of that by buying more shares because I think it's towards the end of the year especially if we have a small correction it's only going to get better from there.
That's why I have continued to stay long in the portfolios that that all we all participate and I thank you for that in our portfolios have been taking some profits in certain stocks we've got some stocks that made two hundred 250% we took the profits from that and we've reinvested into other companies that's how you grow a portfolio over the long term so I just wanted to kind of give you the bond basics and what I see and what is bond tapering on today's remember I try to keep these around 20 minutes and I'm 19 minutes and already.
I do quickly want to some people beginning some emails on some comments that I made from the last podcast where people were asking me memorize talk about China last month and I talked about how they made me nervous and I was trying to find some negatives so where are some negatives and the negative that I hit up on that at the time last month was China still spooked me and I talked a lot about the companies that are American companies that do business in china anytime xinping can oust any company because they're not a capitalist society over there they are a totalitarian government and at the head of the totalitarian totalitarian government is general secretary of the Chinese Communist party zhenping so the two companies are going to set aside real quick and I'm going to talk about Alibaba and Baidu companies you may have heard of let's first talk about Alibaba and Alibaba is basically the Amazon of China I think a lot of people revert referred to it the guy who came up with it was a is a guy named Jack ma and we used to always hear about Jack ma he was always on TV he was always writing articles he was speaking all the time and he grew this company that was absolutely on fire just from an economic perspective if you think about it like this UM the revenue that they were bringing in at Alibaba was about 72 billion dollars that's the revenue that's not the value that's the revenue that's a big number.
If you compare it with let's compare it with Amazon I'm looking for my numbers here because I wrote this down I read them but the one day group that one day buying day that they have in China it is very similar to what Amazon does so Amazon puts on their prime day that they hold for two days so it's singles day definitely it singles day it's called singles day it's November the 11th so Alibaba have recorded this this $77 billion in revenues in sales excuse me in one day OK so Amazon's prime day it was 21 times less than what they did in one so that got people fired up there's just a lot of money to be said and so everything is going just fine they're making money everyone's making money and then Jack ma on October the 24th of last year was giving a speech and in this particular speech Jack Moss started out by saying that he was a little bit um nervous about some of the things that he was going to say but he felt that they were necessary and he began to criticize Chinese banks in fact he said they have a pawnshop mentality that is so severe that it affects all entrepreneurs in China and he referred to the people who run the banks as old men who really don't have a concept of what's going on he said China does not have sufficient experts to make policies that align with technological development in companies he was very critical of the government the next week the government asked him to please come in and visit he had a talk with them and since that time Jack ma has been seen or heard of twice so this is a guy who was in front of TV cameras every day this guy had his own television show in China where he was kind like Shark Tank here but he was helping out African upper entrepreneurs and building business and talking to him he's not even on his own show he's not even showing up anymore it's called dumb Africans business heroes that's what it was and they were competing for U.S. dollar prizes I believe the prize if you won that was $1.5 million he stopped posting on Twitter he had over 600,000 followers and then also he gives a speech every year or had been since 2016 at the UM the Shanghai Chamber of Commerce this forum doesn't show he just has not been seen or he made a couple of appearances it wouldn't shock me if they locked him up for a little while and so you're going to keep your mouth shut.
Jack ma also then started a finance company called Ant group Ant group was supposed to go public this was going to be one of the largest upper IPO's in history when this was getting ready to happen and then all of a sudden it disappeared the CCP or the Chinese Communist party just said you know what we're not going to do this we're not going to allow this so forward we're going to take a look at it in other words we're killing this deal so as an American investor and this is where I was getting these emails people saying what about bottle can I buy these what do you actually buying when you own shares of Alibaba or Baidu if you're buying that trade on the Dow Jones and your drive that trade on the American exchanges excuse me what you actually own is a piece of paper that's called that's normally called an ADR an American depositary receipt which is the same thing as basically shares in the company but it trades here but that's not what you own when you own these Chinese stocks they had to create something that replicated or on the New York on the American exchanges and they came out with this it's called of IVE, a variable interest equity so it's an essence just a piece of paper that says I own a percentage of some of the revenues that the parent company owns when you own one of these don't own stock in the company it feels like you do it looks like you do when you get your statement it sure looks like you do because you have X amount of money that went up or down but in reality is you own nothing but a small piece of paper the Chinese government has already said they don't like these VIE’s I am betting they're going to just up and say guess what I'm done with these were done with these were not going to recognize him anymore so for everybody that owns shares in these VIE’s are they own parts of Baidu or they own parts Alibaba the next day you won't actually nothing and since you're not a stock holder in the company you cannot go through the normal court system that you would go through here for recompense you can't sue you can't you can't go to appeals for it you can't do anything because it's a Chinese company and when when ximping makes that decision it is game over and there's no coming back so to answer these emails that were coming into me and that why are you being so hard on Chinese companies that's the basis of why I don't like investing and non-capitalist countries.